Question

Entire Market Representative Firm 30T S1 30 25 S2 25 MC ATC AVC 20 S3 20 Price ($/gallon) 15 Price ($/gallon) 1 15 10 10 5 5 D - 0 + 0 -- 0 2 4 6 8 10 12 0 1 2 3 4 5 6 Q (thousands of gallons/week) Q (hundreds of gallons/week)

• If the market supply curve is given by S1, then what will happen to the market supply curve in the long run?
• If the market supply curve is given by S2, then what will happen to the market supply curve in the long run?
• If the market supply curve is given by S3, then what will happen to the market supply curve in the long run
• In the long run, what will the equilibrium price per gallon be, and what will each firm's profit-maximizing quantity per week be?
• In the long run, how much profit will each firm in this industry earn each week?

Answer 1

If the market curve is S1, then P=$20 per gallon which is higher that ATC. The firm will supply 400 gallons per week ( MC= MR. MR=P). The firms in the industry are making economic profit. This will attract new firms into the industry and the supply will increase. This will continue till the equilibrium price is once again reached. Entry and exit are free in perfectly competitive market.

If the market curve is S2, then P=$15 per gallon which is equal to minimum ATC. The firms in the industry are making normal profit as the industry is in long term equilibrium ( MR= MC= ATC). MR= P.  Firms will neither exit nor enter the industry. The equilibrium quantity is 300 gallons per week.

If the market curve is S3, then P=$10 per gallon. The quantity supplied would be 200 gallons per week. The ATC is $20 per gallon which is higher than P. So the firms are making economic loss. Firms will exit the industry and supply will fall till the equilibrium price is reached once again.

If the market curve is in long term equilibrium,  then P=$15 per gallon which is equal to minimum ATC. The equilibrium quantity is 300 gallons per week.The firms in the industry are making normal profit as the industry is in long term equilibrium ( MR= MC= ATC). MR= P.