Question

2. Competitive Firm Equilibrium Long run, Exit/Entry in Long Run, Explain why a competitive firm can only earn normal economic profit (define) in long run.

3. Define monopoly, explain why the MR and P( AR) curve for a monopolist are different and why they are downward sloping and why does MR lie below the AR curve. Compute Monopoly P and Q and profits; compare monopoly price/quantity/profits with a competitive market price and quantity. Compute CS, PS, TS for monopoly as well as competitive market. Compare CS, TS, monopoly vs competitive markets; compute and explain the deadweight loss of monopoly markets. Use the comparison to comment on the antitrust laws of the country

Answer 1

2).

The main reason that all the firms in a competitive market earn normal economic profit is the “free entry and exit firms”. In the perfectly competitive market there is “free entry and exit of firms”, implied if all the existing firms earn positive economic profit that will attract new to enter into the industry. Similarly, if all the existing firms losses that will cause few existing firm to exit the industry. Consider the following fig.

Here the initial market price is “P1” the intersection of market demand D1 and market supply S1. Here the optimum production by individual firm is determined by the condition P=LRMC, => all the existing firms are producing “q1 units” of the good. Now, here there is a LR equilibrium and price is equal to LRATC, => all the firm are getting normal profit.

Now, let’s assume the market demand increases to D2, => the equilibrium price increases to P2 and all the exiting firms increases their production to “q2 unit”. Now, at “q1” price is more than ATC, => all the existing firms are making positive economic profit, that will attracts new firms to enter into the industry. So, as the new firms enter into the industry the market supply schedule starts shifting to the right and the equilibrium price starts failing. This process will continue until price will get back to ATC, => the initial level P1. So, once the price decreases to P1 the entry of new firms stops and the individual firms reduce their production to the initial level “q1 units”, and all the existing firms earn normal profit that is zero economic profit.