Question

Consider the following information about a firm’s long-run total costs (assuming that other firms could produce at the same cost values):

qA	TC
0	0
100	2200
200	3600
300	5400
400	7600
500	10000

(a) (12 points) For each value of qA (except when qA = 0), provide the numerical value of the firm’s average total cost AC. Then, compare these AC values with the firm’s AVC (average variable cost) values at each value of qA. For any given level of qA, how are AC and AVC related? Why? (b) (12 points) Suppose that the market price is P = 20. What is the firm’s profit-maximizing level of output qA*? [P is the per-unit price at which A can sell its output.] (c) (10 points) Will the firm operate or shut down if P = 20? Why? (d) (8 points) Suppose that when P = 20 there are initially 1000 firms producing output. Compared to 1000, how many firms (i.e., 1000, more than 1000, less than 1000) will there be at long-run equilibrium? In answering this, provide the definition of long-run equilibrium. (e) (10 points) What is the specific value, here, of the long-run equilibrium price? (f) (8 points) Briefly explain (as precisely as possible) what the long-run market supply curve looks like, and why. What happens to the market price in the long-run if market demand rises?

Answer 1

qA	TC	AC (TC/q)	P	TR (P*q)	MR (TR/q)
0	0		20	0
100	2200	22	20	2000	20
200	3600	18	20	4000	20
300	5400	18	20	6000	20
400	7600	19	20	8000	20
500	10000	20	20	10000	20

a) At each value of qA, AC=AVC because there is no fixed cost in this case as at the level of zero production total cost is zero.

b) Firm’s profit-maximizing level of output is where MR=MC, thus the required level of production where the profit is maximum is at 500 units of production

c) Will operate as price ($20) is greater than average variable cost (shutdown occurs when in short run P<AVC and it exit from the market in long run when P<ATC)

d) 1000 firms because in long run price is equal to average total coast at production level as there is zero economic profit and in this case P=ATC is at $20 ( because in long-run equilibrium of a perfectly competitive market with free entry and exit the firms operate at their efficient scale level where price equals marginal cost and average total cost as at this level ATC is minimum and also it has zero economic profit)