Question

Q3

a. Using both a market model and an individual firm’s set of cost curves, show a perfectly competitive firm that is earning losses in the short run. Then, show and clearly explain the long run adjustment process that will occur.

b. For each of the market structures we studied (perfect competition, monopolistic competition, oligopoly and monopoly) give an example of a real world industry that would fall under each classification.

Answer 1

a. The graph:

As we see in panel (b), the firm's average cost is greater than the price. Hene it is incurring losses. In the short run, it will shut down if price < average varianble cost. This is because it will save losing variable cost. It must incur fixed cost even if the production is zero. But by shutting down production temporarily, it will atleast save variable cost.

In the long run, those firms that cannot sustain losses will exit the market. Thus the quantity supplied will decrease. This will exert an upward pressure on price. Price will increase till it reaches AC, and firms will break even. They will operate at zero economic profit.  This is the long run equilibrium of a firm in perfct competition.

b. Examples:

(i) Perfect competition: vegetable market, wheat, corn, fish,

(ii) Monopoly: Ameican Elecric Power, Columbia Gas

(iii) Oligopoly: Southwest Airlines, T-Mobile, GMT, Fiat Chrysler

(iv) Monopolistic competition: restaurant, show retailer, hairdressers