Suppose you are given the following information about a particular industry: Q_D

Question

Suppose you are given the following information about a particular industry: Q_D = 45,000 - 5,000P Market demand Q_s = 25,000? Market supply C(q) = 400 + q^2/400 Firm total cost function MC(q) = q/200 Firm marginal cost function Assume that all firms are identical and that the market is characterized by perfect competition. b. Would you expect to see entry into or exit from the industry in the long run? Explain. What effect will entry or exit have on the market equilibrium? c. What is the lowest price at which each firm would sell its output in the long run? Is profit positive, negative, or zero at this price? Explain. d. What is the lowest price at which each firm would sell its output in the short run? Is profit positive, negative, or zero at this price? Explain.

Explanation / Answer

With the given market demand and market supply, the equilibrium price and quantity in the market is given by:

QS = QD

25000P = 45000 - 5000P

30000P = 45000

P* = 1.5, Q* = 37500

From a firm's perspective, Profit maximizing quantity is the one that equates MR=P=MC

q/200 = 1.5

q = 300. With each firm producing 300 units, there are now 37500/300 or 125 firms.

Looking at the cost faced by each firm, we have

C = 400 + 300*300/400 = 625

VC = 300*300/400 = 225 and hence,

AVC = 225/300 = 0.75 and

ATC = C/Q =

= 625/300

= 2.08

a) Since the firm has to take price of 1.5 as given, and its ATC in the short run exceeds the price (2.08>1.5), there are economic losses. So firms in this industry will leave in the long run. As the exit will continue, all the economic losses will vanish. Firms will find their supply increasing, their cost will reduce as they increase production. In the long run, fewer firms will be operating. Market equilibrium will change.

b) The lowest price a firm would charge in the long-run is the minimum of ATC which is tangent to the price line implying, P= ATC. At this price, currently there are losses of about $0.58 per unit or $174 in total

c) The lowest price a firm would charge in the short-run is the minimum of AVC which is tangent to the price line implying, P = AVC. At this price, currently there are profits of about $0.75 per unit or $225 in total.

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