Question

1. In a perfectly competitive market, what is the effect of an increase in marginal cost on equilibrium price and quantity? Under what conditions does the increase in equilibrium price equal the increase in marginal cost?

2. If equilibrium price increases by less than an increase in marginal cost, what is the response by a competitive firm in setting its output?

Answer 1

Answer 1. )

If there is an increase in marginal cost, then the equilibrium price will also increase because in a perfectly competitive market marginal cost is equal to price. Assuming the good to be a normal good, the equilibrium quantity will decrease with an increase in price.

Answer 2.)

If the increase in price is less than an increase in marginal cost, then the decrease in output would be less than what it was supposed to be. The competitive firm would decrease its output at a lower rate.