Question

In a particular market there are several hundred firms, all of the firms produce an identical product, and it is easy to get in and out of the market. At the current market equilibrium we observe the following for a typical firm:

P=100

MC=100

ATC=75

1. Find the firm's marginal revenue
2. Is this firm maximizing profit? Explain how you can tell.
3. Find the firm's profit.
4. What two things must be true for a competitive market to be in a long run equilibrium?
5. Is this market in a long run equilibrium? Why or why not?
6. What do you expect to happen to the price in this market? What do you expect to happen to the number of firms in this market

Answer 1

Given,

P = MC = $100; ATC = $75

It is given that several hundred firms exist in the market. Therefore, the market is a perfectly competitive market. In a perfectly competitive market, the marginal revenue of a firm is equal to the market price of the good. Therefore, MR = $100

As the profit-maximizing rule of P = MC is met, the quantity is the profit-maximizing quantity.

Profit = Total Revenue - Total Cost = Price * Quantity - ATC * Quantity = (P - ATC) * Q = ($100 - $75) * Q = $25Q (As the quantity supplied by the firm is not given, the numerical value of profit cannot be found)

For a firm in a competitive market to be in long-run equilibrium, the following must be true

a. MC = ATC (The MC and the ATC curves intersect at the minimum point of ATC curve)

b. P = MC

Therefore, the long-run equilibrium condition is P = MC = ATC (As P = ATC, the long-run economic profits of a firm in perfect competition is 0)

The given market is not in a long-run equilibrium as the price (P) is greater than the ATC (P > ATC)

As the long-run equilibrium occurs at a price equal to the minimum ATC, the price in the given market is expected to decrease in the long-run.

We observe that in the given market, the firms are earning a positive profit. Therefore, new firms enter the market in the long-run in search of profits. (As new firms enter, the supply increases and as a result the price decreases up to a point at which the positive economic profits of the firms are eliminated i.e., up to the price equal to the minimum ATC)