Question

Q2 2a [5 marks] Look at the graph at the bottom. If the market price is $4.50, calculate the firm's economic profits or losses in the short-run. Price ATC AVC UTTTTTTTT TTT 0 1 2 3 4 5 6 7 Quantity 2b [5 marks] You learn that in the market at this price the total quantity transacted is equal to 7,040. How many firms are operating in the market? What are the industry profits/losses? 2c [5 marks] If the firm in the graph is representative for all other firms in the industry, what will be the market price in the long run? Describe briefly how the market moves from the short-run to the long-run.

Answer 1

Ans) In Perfectly competitive market there are many sellers selling homogeneous products. Firms are price takers and there is ease of entry and exit.

A profit maximising firm produces the quantity where MR and MC curve intersect.

1)

Price MC -MR=D ATC AVC 0 TT TTT 0 1 2 3 4 5 Quantity 6

Price -MR=D Profit ATC AVC ATC Quantity 0 1 2 3 4 5 6 7

Here, since price is more than ATC, firm is earning positive economic profit.

Q = 5.5

Profit = (P - ATC) × Q = (4.5 - 3)×5.5 = $8.25

2) Number of firms = total output ÷ output by single firm = 7040÷5.5 = 1280 firms

Profit of industry = profit of single firm × number of firms = $8.25 × 1280 = $10,560

3) Due to ease of entry and exit, firms in the long run, in competitive market, earn zero economic profit. Here, since price is greater than ATC, and firms are earning positive economic profit, more firms will enter the market. As a result, supply will increase and price will decrease. Price will decrease till it reaches minimum of ATC, where firms earn zero economic profit.

(Opposite happens if price is less than ATC).

Long run price = minimum of ATC = $3.