Question

Instructions: Where applicable, enter your answers to 2 decimal places. Also, use / for divide, * for multiply, ( ) to put terms in parentheses, and ^ to raise to a certain power. Use $ for monetary terms but do not use a comma.

Consider that a perfectly competitive, constant long-run cot industry with identical firms is currently in long run equilibrium. The market demand is described by the equation Q = 2020 - 2P and the total cost function for each firm is C(q) = 0.5q² + 10q + 50.

1. With the long run equilibrium price in this industry? (4 points)

The long run equilibrium price is $Blank 1.

2. Currently, how many firms are there in this industry? (4 points)

Currently, there are Blank 2 firms in this industry.

3. What is the short run market supply equation? (4 points)

The short run market supply equation is Blank 3

Suppose consumers become pessimistic about the future and the market demand in this industry decreases to Q = 1620 - 2P. The current market price is $18.

4. What is the firm's current (short-run) profit-maximizing level of output? (4 points)

The firm's current (short-run) profit-maximizing level of output is Blank 4.

5. As the market adjusts in the long run, what would one expect in the long run equilibrium? (4 points)

In the spaces provided, complete the sentence using one of the following words or phrases in red: decrease | increase | not change | remain the same.

As the market adjusts, one would expect the market price to Blank 5, the market supply to Blank 6, the number of firms in the market to Blank 7, and the firm's profit to Blank 8.

6. What is the market quantity in the long run equilibrium? (4 points)

In the long run equilibrium, the market quantity is Blank 9.

7. How many firms will be in the market in the long run? (4 points)

In the long run equilibrium, there will be Blank 10 firms.

Answer 1

1. The long run equilibrium price would be equal to the minimum average cost. The representative cost function is , and the average cost would be as or or . The AC would be minimum where or or or or or or . The minimum AC would be hence or or dollars. Hence, the long run equilibrium price is $20.

2. The marginal cost of firms is or or . The firm would produce at where MC=P, ie where or or units.

The equilibrium quantity would be as or or .

The number of firms would be hence . Hence, there are currently 198 firms in the market.

3. The short run market supply equation would be . The reason being that the long run market supply curve is horizontal at where P equals the minimum AC, in the constnat cost industry. The constant cost industry is assumed since the cost function doesn't change (and hence the AC does not shift upward or downward) as new firms enter the market.

4. The short run profit maximizing production level would be where MC=P, which would be where or or units. The short run profit maximizing output is hence 8 units.

5. As the market . . . price to increase, the market supply to decrease, the number of firms in the market to decrease, . . . firm's profit to increase.

The long run price, which depends on the cost function and AC, would not change as the change in demand would not cause change in the costs. As the current price is less than the long run price, the prices would increase in the long run. The market supply would be decrease since at lower demand, the number of firms would decrease as price increases.

The number of firms would decrease. In this case, we have the short run equilibrium quantity as units, and the number of firms in the short run would be . As this was also before the demand decreased, after the demand decreases, in the long run, equilibrium quantity would decrease, and hence the number of firms would decrease. The firm's profit in the short run is negative since the price is below the minimum of average cost. In the long run, the firms makes zero-economic profit, implying that the profit would increase.

6. The equilibrium quantity in the long run would be units.

7. As before, at P=20 each firm would produce units. The number of firms in the long run would be .