Question

3) Perfectly competitive markets

   

# of Contraptions

Total Cost

0. 0 500

1. 1 580

2. 2 640

3. 3 690

4. 4 730

5. 5 760

6. 6 800

7. 7 850

2

8 950

9 1200 10 2000

a) Calculate the marginal cost for contraptions, given the above information, add it to your Table, and graph it.
b) Where does diminishing returns set in? Explain how you know.
c) If market price equals $100, how many units should be produced? What is revenue? What is profit? Add these columns to your Table too.

d) What is the fixed cost? Would the number of units produced change if the fixed cost went down? Why or why not?
e) Firms now exit the contraption market, and contraption price goes up to $250. Graph this result, showing market and firm graph side by side. How many units will a firm with the above cost function produce? What will profit be? (It might be helpful to show a new Table or at least add a couple of columns to the existing one).

f) At this point, will more firms exit, or will new firms start to enter the market? Explain.
g): What is the long run equilibrium price? What is profit? (Show all calculations) Why will firms not leave the market?

Answer 1

# of contraptions	Total Cost	Marginal Cost	Total Revenue	Profit
0	500	-	0	-500
1	580	80	100	-480
2	640	60	200	-440
3	690	50	300	-390
4	730	40	400	-330
5	760	30	500	-260
6	800	40	600	-200
7	850	50	700	-150
8	950	100	800	-150
9	1200	250	900	-300
10	2000	800	1000	-1000

Total Revenue = Price * # of contraptions = $100 * # of contraptions

Profit = Total Revenue - Total Cost

a)

b) The diminishing returns set in when the marginal cost starts increasing. From the above table, we observe that the marginal cost starts to increase from the 6th unit. Therefore, the diminishing returns set in when the # of contraptions = 6

c) When the market price = $100, the profit-maximizing output is the maximum quantity up to which the MC remains less than or equal to price. From the above table, we observe that the MC = P = $100 when the # of contraptions = 8.

Therefore, 8 units must be produced. At this quantity, the revenue = $800 and the profit = -$150

d) Fixed Cost = Total Cost at zero output = $500

The value of fixed cost does not change the quantity of production. The fixed costs are considered as sunk costs and hence are already incurred. The marginal cost does not include any change in the fixed cost. Therefore, the quantity of production does not change with fixed costs.