Question

Suppose that the restaurant market is a perfectly competitive industry in long run equilibrium. Each of the identical restaurants has the same (long run) cost function: T C = 225 + q 2 , where q is the volume of sales by each establishment. Each of the identical firms therefore have the same marginal cost: MC = 2q. (a) What is the average cost function for the identical restaurants? (b) How much does each individual firm produce in the long run competitive equilibrium? (c) What price do you expect to observe in the long run competitive equilibrium? Page 2 (d) If the market quantity demanded at the price you solved for in (b) is 3,000, how many restaurants do you expect to observe in the marketplace? (e) What can you say about the economic profits earned by each of the individual restaurants? Does the same statement hold true for accounting profits? Why or why not?

Answer 1

For a market in perfect equilibrium,

a)

The average cost is 30

b)

Each individual firm produces 15 units in the long run.

c)

In the long run, price will be equal to 30

d)

There will be 200 firms operating in the long run.

e) The economic profit earned by each of individual restaurant will be zero. In case the economic profit earned is non zero, more players will enter the market and bring the value down to zero. Economic profit is defined as any profit which is more than the normal profit. The normal profit will be there which is the profit to compensate the owner for the opportunity costs. So, the accounting profit will not be zero. (Because the firms earns normal profit). But economic profit will be zero.