Question

1) Initially, there are thousands of identical bottled water distributers. Assume the bottled water industry is a constant cost industry characterized by perfect competition.

a. Use both firm-level and market-level diagrams to show the initial long-run equilibrium price and quantity in the market (P and Q) as well q, MC, ATC and MR and P for the typical firm. Label any profits or losses, if any.

b. Now suppose that all firms adopt a new technology that reduces the cost of bottling water. Use the diagrams to illustrate the short-run position of the typical firm after the technology is implemented. Be sure to clearly label q, MC, ATC, MR and P for the typical firm in this SR position. Label any profits or losses, if any. Explain what is happening in words as well.

c. What will happen to get the firm and the market back to a long-run equilibrium? What happens to output for the firm and the market as the industry transitions to the long-run. Explain in words and show graphically.

d. How do you know when the market finally reaches the long-run? Describe and fully label the long-run equilibrium. In your diagram, is the typical firm producing more, less or the same as in part A? Is the typical firm producing more, less or the same as in part B? Is the new equilibrium quantity in the market more, less or the same as in part A? Has the number of firms changed? If so, how?

Answer 1

A).

Consider the following fig.

So, here “D1” and “S1” are the industry demand and supply curves and “E1” be the industry equilibrium, => “P1” and “Q1” are the industry price and output respectively. So, at the price “P1” the firm will choose to produce “q1” by the intersection of “P1” and “LRMC1”. So, here the price is exactly equal to the “LRATC1”, => all the firms into the industry earn normal profit, => zero economic profit.

B).

Now, assume that all the firms adopt new technology that reduce the cost, => the LRATC and LRMC curve will shift downward, => the new cost curves are given by, “LRATC2” and “LRMC2”. So, the new SR equilibrium is given by the intersection of “P1” and “LRMC2”, => “A2” be the new SR equilibrium, => the SR production by firms increases to “q2” from “q1”. So, here the profit is given by the rectangle “P1B1B2A2”. So, here as all the firms adopt new technology they starts getting positive economic profit.

C).

Now, all the existing firms starts getting positive economic profit, => new firms will starts entering into the industry that will increase the industry supply, => the industry supply curve starts increasing and will continue to shift until the profit will be zero.

So, here the new supply curve is “S2” and the new price is “P2” the intersection of “D1” and “S2”, => at this price the economic profit is zero, => all the existing firms will earn normal profit.

D).

So, here “E2” be the another LR equilibrium where individual firms are producing “q1” the initial level of output but less compare to “part B”. The overall industry output is more compare to “part A” and numbers of firms are also more compare to the “part A”.