Question

QUESTION 12 In class, we discussed the impact of an increase in demand for a good in a constant cost industry, In your own words, describe the underlying mechanism in the short and long run in this market. What is happening to equilibrium quantity and price over time? TTTT Paragraph Arlal ► 3 (12pt) %DO TT, Words: 0 Pathp QUESTION 13 Solve mathematically and provide the answer below. A monopolist faces the demand curve D: P-10-Q and produces at MC-4 What are the profit maximizing price (p) and quantity (OM) in this market?

Answer 1

Answer 12) A constant cost industry is an industry in which the increase in procurement of inputs or an increase in the scale of production does not lead to a change in the per unit cost of inputs. This means that the entry or exit of firms does not affect the cost curves of the firms in the industry. It is characterized by a horizontal long run supply curve. The pencil industry is considered to be a major example of this.  

The difference between the long run and the short run is that firms get an opportunity to enter or exit the industry. This is not possible in the short run.

The Short run

In the short run, this works like any other regular industry. An increase in demand leads to an increase in price. This motivates the producers to increase the supply. The increase in price reduces the demand over time until the market finds a new equilibrium (which is at a higher price compared to the original situation).

The long run

An increase in demand of the good leads to an increase in its price due to which the market equilibrium shifts upwards and the firms start earning a profit compared to the zero profit situation in the original equilibrium. This attracts more and more firms into the industry. The entry of new firms will reduce the profits and the price due to the increasing competition. Since the cost of inputs does not increase with the increase in the number of firms, new firms will continue to enter the market until we come back to the original zero profit equilibrium and the original supply. Hence, the supply will be constant (a horizontal line) in the long run.  

In order to understand this in a better way, please refer to the diagram below.    

Industry Firm MC Di AC /21 Pi P Ls Si an 92

E is the original equilibrium with D and S being the original demand and supply curves respectively. The firms are operating at Z where AC=MC (Normal/ Zero profits). When the demand rises, the demand curve shifts from D to D1 and increases the Price from P to P1 and the quantity to q2 from q1. This leads to a profit for the firms [(MC-AC)*100] at Z1 which then attarcts more and more firms to enter the market. The entry of these new firms will shift the short run supply curve to the right (S1) and this increased competition will reduce the profits, price and supply. Due to the constant costs (No change in cost of input with change in output), the price will reduce until we reach the original zero profit situation with Price P and supply S. Hence, in the long run, the supply and price will be constant.

Answer 13) Profit maximizing condition is MC = MR

P = 10-Q - Equation 1

Multiplying both sides by Q

PQ = 10Q - Q² = TR (TR=P*Q)

MR = 10 - 2Q (We get MR by differenciating TR with respect to Q)

MC = 4 (Given)

MR = MC, 10 - 2Q = 4

Hence, Q=3

By putting Q=3 in equation one we get P= 10 - 3 = 7

Therefore, Profit maximizing Q=3 and P=7