Question

1. Perfect Competition Consider a market that faces the following market supply and demand functions QS = -2+2 QP = 10 - 5P where identical firms face the total cost function of TC = 4+2+72

a) What is the market price? p = 8

b) Derive the average variable cost, average total cost, and marginal cost function.

                avc = 1 + q

                atc = 4/q + 1 + q

mc = 1 + 2q

c) In the short run, how much does each firm produce?

                qs = 6

d) In the short run, how much economic profit or loss will be obtained?

                ep = 2

e) Based on the results in part (d), will firms want to enter or exit the market? Why?

f) In the long run, what is the market price? (Hint: You can find the long run firm quantity by setting two of the cost functions equal to one another)

Answer 1

e) The economic profit is still >0. Until the profits are driven to zero, firms won't exit the market. They will want to enter the market because there still are profits in the industry.

f) In the long run, there are zero economic profits. Here, price equals average total cost which equals the marginal costs. So we equate atc and mc as shown below:

atc = mc

4/q + 1 + q = 1 + 2q

q = 2.

Substituting this value of q in atc cost function, we get:

p = atc = 4/q + 1 + q

p = 4/2 + 1 + 2

p = 5.

Therefore, the long run price = 5