Question

1) Imagine a perfectly competitive market that is currently in a long-run equilibrium with price=$10, individual firm quantity set at 10 units, and 100 active firms. Scientific discoveries about the health benefits of this good lead to a permanent increase in demand for this good (but no changes in firm costs).

Once the market is able to fully adjust, then compared to the original long-run equilibrium, the new long-run equilibrium will have

A) a lower price and fewer active firms

B) the same price, but fewer active firms

C) the same price, but more active firms

D) a higher price and more active firms

2) On the downward sloping portion of a firm's long-run average cost curve (LRAC), it is experiencing

A) diseconomies of scale

B) diminishing marginal returns

C) economies of scale

D)constant returns to scale

3) True/False: In the short run, a firm suffering losses will continue to operate (produce some positive quantity) as long as the price at least covers average variable cost.

A) True

B) False

Answer 1

1> C) the same price, but more active firms

In the long run equilibrium, the price of the product becomes the minimum average total cost of the product, so the price will stay the same, but due to higher demand, there will be more active firms supplying the product.

2> C) economies of scale

Downward sloping LRAC means that with a rise in quantity, the average cost of production falls, so this must be the case of economies of scale.

3> True

Since fixed cost is a sunk cost in the short run, the firm should continue producing till the point it can cover its average variable cost.