Question

Suppose the market for canola oil is perfectly competitive. There are 1,000 firms in the market, each of which have a fixed cost of FC=2 and a marginal cost of MC= 1+Q, where q is quantity produced by an individual firm. Let QS denote the total quantity supplied in the market. The market demand is QD= 15,250-250P

A) Find the market supply equation, that is write QS as a function of price P

B)What is the equilibrium price? What is the equilibrium quantity of canola oil bought and sold? How much profit is a given firm making? Are firms profit maximizing at this equilibrium? Show your calculations?

C) Can you tell if this is a long run equilibrium? If not, how would a long run equilibrium be different?

D) How would an increase for demand of canola oil affect the quantity produced by each firm in the short run? How would it affect their profits in the short run? Use a supply and demand diagram to support your answer.

Answer 1

Each of the 1000 firms has a fixed cost of FC = 2 and a marginal cost of MC= 1+Q, where q is quantity produced by an individual firm. The market demand is QD= 15,250-250P

A) Each firm has a supply equation of q = MC - 1 or q = P - 1. For 1000 firms, market supply is 1000q = Qs = 1000P - 1000.

B) At the equilibrium Qs = Qd

1000P - 1000 = 15250 - 250P

1250P = 16250

P = $13 and so Q = 12000. This gives q = 13 - 1 = 12 units.

Equilibrium price is $13 per unit and the quantity of canola oil bought and sold is 12000 units.

Profit = 13*12 - 2 - 13*12 = -2. Each firm is making a loss of -2.

C) This is not a long run equilibrium because in the long run there would no economic losses (or profit) to any firm.

D) Increase in the demand of canola oil will shifts the demand curve to the right, raising the price and increasing the quantity produced by each firm in the short run. This would reduce their losses or increase their profits in the short run

Price and cost ($) Price and cost (5) MC ATC DD DDI MR = AR --PI-' Economic profit PO Quantity Quantity QO Q1 a) Market | 70 71 b) Single firm Figure 1 Increase in demand and short run economic profits