Question

QUESTION THREE [15]

3.1 Questions 3.1 to 3.2 is based on the excerpt below. Shine is one of many firms in the market for toothpaste which is in short-run equilibrium. It engages in advertising to create the perception of a unique product. Discuss the long-run aggregate supply curve.

3.1.1 Draw a diagram illustrating Shine’s demand curve, marginal revenue curve, average total cost curve and marginal cost curve, clearly labeling the company’s profit maximizing output, price and equilibrium position. Include in your answer how the profit position is determined. (10)

3.1.2 Determine why Shine is able to establish this profit position in the short-run, using the characteristics of the market structure this firm falls within as the basis for your answer.

Answer 1

Below is the market structure of perfectly competitive market whose Shine is a part of. Long run supply curve is a vertical straight line parllely to price axis passing through the point where demand and supply curve intersects.

3.1.1) In the middle diagram of the above picture, you can see that Shine can earn profit of the shaded rectangle where price they charge is more than average total cost when MC = MR. Profit maximizing situation occurs when MR = MC.

3.1.2) In long run, Shine would not be able to maintain their profit in long run because many new firms would enter in this industry (there is no barrier to enter and exit) after observing their profit in short run. Whole profit from market will be distributed among all firms in long run which reduces the profit such that they are able to earn nornal profit where total revenue = total cost.