Question

1. Suppose the industry of all farms planting beans is now in a perfectly competitive longrun equilibrium, and all farms have zero fixed cost for planting. Recent regulation in the market of fertilizers raises the price of bean fertilizer and therefore the marginal and average costs of all the farms in this industry. Note that marginal and average cost curves both experience a parallel shift up by the same amount. Please use a graphic tool to analyze the following changes to each individual farm and to the entire industry:

(a) (8 points) Set up a diagram, for both individual firms and the industry, to show the longrun equilibrium before the fertilizer shortage. Clearly mark the market price (p), individual supply (q), and the industry supply (Q).

(b) (12 points) Suppose the fertilizer shortage takes place but the price for beans has not yet adjusted accordingly (no entry or exit either). How much will each existing farm produce (mark your answer as q1 on the same graph) and how much profit or loss are they getting (make with a shaded area on your graph)?

(c) (16 points) As time goes by, will this industry experience any entry or exit? How will the price start to adjust? Explain your answer. Mark on your graph the new long-run industry supply, the new equilibrium market price (p’), the new individual supply (q’), and the new industry supply (Q’).

2. Suppose one Japanese firm and one American firm dominate the US market of widgets. They share the same cost structure: TC = 250 + 40q. The only demand for widgets is in the US and is p = 100 – Q.

(a) (16 points) If these two firms compete in quantity at the same time, what is the Cournot equilibrium output, price, profit level by each firm?

(b) (12 points) Suppose the American firm acquires the Japanese firm and therefore becomes a monopoly in this market. Calculate the monopoly’s output, price, and Lerner Index. How much is the deadweight loss due to monopoly behavior?

Answer 1