Question

Return again to the market for good G, and illustrate movement back to long run equilibrium both in the market for good Gand for firm j. What is the profit situation of firm j? PROBLEM 3 Assume perfect competition exists for Good W, and assume the market is in long run equilibrium. Depict the market for good W, and indicate initial supply, demand, equilibrium price and quantity with subscript 1. To the right of the market, depict the long run equilibrium situation for firm, that is one firm that produces good W depicting all firm curves with subscript 1. Return to the market for good W, and illustrate the short-run effect if there is an increase in consumer preference for good W; depict all changes with subscript 2. What is the profit situation of firm j? Return again to the market for good W, and illustrate movement back to long run equilibrium both in the market for good Wand for firmj. What is the profit situation of firm j? PROBLEM 4 Assume perfect competition exists for Good M, and assume the market is in long run equilibrium.

Answer 1

In the above diagram, D1 and S1 are the initial demand and supply curves respectively. The market for good W is in equilibrium at point E1, where demand and supply curves intersect. OP1 is the equilibrium price and OQ1 is the equilibrium quantity. The diagram on the right shows the firm j which is in long run equilibrium. LMC1 is the long run marginal cost and LAC1 is the long run average cost . The firm is in equilibrium at point R1, where LMC=MR.(P1).The equilibrium price is OP1 and equilibrium quantity is OM1. The firm j earns normal profits in the long run i.e., just covering their costs.

y 1 Dz Smca SAC - ARIMA AR/MR Mi Max Q1 Q2 MARKET FOR GOOD W. FIRM J

An increase in consumer preference for good W, causes the demand curve to shift to right. The new demand curve is D2. The curve D2 and S1 now intersect at point E2. E2 is the new equilibrium point. An increase in demand in the short run causes the equilibrium price to rise to OP2. As firms are fixed in the short run, existing firms increase their production and quantity supplied in the market also increases to OQ2. As the price rises to OP2, the firm j is in equilibrium at point R2, where SMC2=MR(P2). Here in the short run SMC2 is short run marginal cost curve and SAC2 is the short run average cost curve. The equilibrium quantity supplied by firm j increases to OM2. Here the firm is making economic profits as the rise in price exceeds all the costs and hence the firm makes economic profits equal to P1SR2P2 i.e., the shaded portion.

I y ↑ DI D2 si sz Ez . LMC2 LAC2 -ARMR RA C ARMR by MI M2 x O QI QzWY 0 MARKET FOR GOOD W FIRM J

As in the short run, existing firms earn economic profits, new firms would be attracted to enter the industry and earn these economic profits. As new firms enter, the supply curve of the market will shift to the right. This rightward shift of the supply curve with an unchanged demand curve causes the equilibrium price to fall to original equilibrium price and equilibrium quantity increases in the market as more firms have entered.

In the diagarm above, the supply curve of the market shifts to right. The new supply curve is S2. The demand curve D2 and supply curve S2 , intersect at equilibrium point T, whhere equilibrium price is OP1, the original long run equilibrium price. The equilibrium quantity is OW. As the price falls to OP1, the firm j is now at equilibrium at point R1, where LMC2=MR(P1). As price falls, the equilibrium quantity supplies by firm j reduces to OM1. The firm is now earning normal profits i.e., just covering their costs.