2. A perfectly competitive, constant-cost industry has a market demand curve P =

ID: 1113739 • Letter: 2

Question

2. A perfectly competitive, constant-cost industry has a market demand curve

P = 50 – (1/7)Q.

Each firm has a U-shaped long-run average cost function with a minimum of $10. The

efficient scale of production for these firms is 5 units.

a) What is the long-run equilibrium market price and quantity?

b) What is the long-run number of firms in the industry? How much does each

produce? What are their profits?

c) Suppose that market demand drops so that the new demand curve is

P = 40 – (1/7)Q. If the short-run marginal cost of firms is SMC= 2q – 5, what

is the short-run equilibrium price and quantity in the market? What is the

output of each firm in the short run?

d) Now find the new long-run equilibrium price and quantity. What is the new

equilibrium number of firms?

a) Long run equillibrium price = minimum ATC (Economic profit = 0)

Long run equillibrium price = $10

Quantity produced (Qm)= 40 x 7 = 280 units

b) Number of firms = Qm/Qf = 280/5 = 56 firms

Each firm produces 5 units (efficient scale of production)

Profits = 0 (Long run, P = ATC)

Supply curve (firm) is same as the marginal cost curve (firm)

Supply curve (firm) : q = 0.5 x (P + 5)

Supply curve (market) : Q = 56q = 28 x (P + 5)

New market demand: P = 40 - Q/7

Q = 252 units

P = 4

Output of each firm = 4.5

d) Long run equillibrium price = $10 (minimum ATC)

Qm = 30 x 7 = 210 units

New equillibrium number of firms = 210/5 = 42 firms

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