Question

1. a. Graph a competitive firm and market in long-run equilibrium; Explain why it is a long run equilibrium.

b. Graph and explain what happens in the short run with a supported price floor.

c. Assume this is an increasing cost industry. Graph and explain each step through the LR.

d. Show the same but for a price ceiling.

2. Show that whether the producers or consumers directly pay the per-unit tax does not matter. Explain what does determine who pays for the tax.

Answer 1

Graphically all the shifts and functioning are shown above and there detailed explanation is as follows

1. a) A competitive firm is in equibirium when plant produces output equals to long run average cost curve , tangent to market price demand curve, where SAC 1 cuts initially P till then the firm can earn supernormal profits however in long run profits are normal, as in early state it attracts new firms , further dropping profit margins and bringing them to normal

Owing to this price will fall however price of factors rises. Thereafter in long run it will go on till Average cost becomes tangent to demad curve

b) PRICE FLOOR - It is the minimum price that will be given to the producer for given quantity and does not let the price fall below certain level, one finest example of it is labor wage market, this is for MINIMUM WAGE , so that one working can afford to have basic living

c)Long run increasing cost industry - here as shown on right SL is long run supply , when demand rises at first price is P2 and quantity is Q2, however simultaneously new firms enter industry ,bringing right shift in supply curve, as long run industry ,supply curve is upward sloping , so the industry will make more output but only at higher prices

d) PRICE SUPPORT - It is done by government so that the price does not go beyond or above certain level , as shown above if demand rises from D to D1 this will also tend to shift equibirium from E to E1 ,making price high from 500 to almost 650 ,however this is absorbed as government puts puts a particular level to set the price so that excess demand is absorbed

2. No matter tax is given on supplier or buyer . As at the end of transaction , for buyer - he has to give total amount of price i.e. the cost of supplier plus tax ; for supplier - he seek for the net amount that is what buyer pays him without tax . Basically with more taxes the price will rise from Po to P1 and quantity eventually fall from QB to QA , here the demand and supply curves shown are of before tax, the rise in price shown in that rectangle is tax revenue for government however the shaded triangular area is dead weight loss i.e. lost of gains from those units which could not be traded owing to rise in price

TAX INCIDENCE is dependent on the price elasticity of demand and supply ,if supply is more elastic than buyer bears the burden but when demand is elastic then supplier has to take the burden

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