Question

Suppose the U.S. bicycle market is perfectly competitive. The graph below shows the short run cost curves of Ted's bicycle store. Suppose the market price is $29. Is Ted making an economic profit in the short run? Are the profits sustainable in the long run assuming this is a constant cost industry? Briefly explain. MC ATC AVC 35 34 33 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 d/ AFC 0 0 2 3 6 7 9 10 11 12

Answer 1

The market price is $29, at this price Ted’s bicycle store will produce 7 bicycles. The store will choose to produce each level of output where its MC=MR (P). When it produce 7 bicycles, it’s per unit revenue is $29 but per unit cost is $19. Thus it earns a per unit profit of $10. Thus Ted’s store is making economic profit in shortrun.

The positive economic profit is not sustainable in longrun. The economic profit earing situation will attract new bicycle stores into the market. As new stores enter into the market, the market supply increase which will lower the market price. The entry of new bicycle stores will continue till the market price falls to average total cost and in longrun all stores will earn zero economic profit.