Question

in a perfect competion. Also can you be thorough with the answers and the graph

1) Carefully draw the industry Supply/Demand diagram showing an equilibrium Price and Quantity in the industry. Then, to the right of this graph draw the representative Firm's cost curves in a way that shows it making zero economic profits (normal profits). This means that the horizontal Demand Curve (the price from the Industry diagram), faced by the Firms is at their Break-eve Price. INDICATE the zero economic profits on your graph. 2) Now DRAW and EXPLAIN what happens in the INDUSTRY and the FIRM when there is a sudden increase in Industry Demand for this product. You will need to draw two NEW diagrams again, side by side. The industry diagram should show what happens in the industry from the increase in Demand (ie., new Pe & Qe). The Firms diagram should show the new Demand Line (Price obtained from the industry), as well as any profits or losses that the Firms are now making due to the increase in Industry Demand. Careful with this last piecel 3) Due to the profits or losses in question (2), what will happen at the industry level? Will firms join this industry or leave the industry? WHY? 4) In the long run, will the overall industry be larger or smaller and WHY? 5) What will be the level of economic profits the representative firms make now (after question 4)?

Answer 1

Answer 1.

Price | Price I s Ате. ------- Avc P, E-. DAEMR, --- i D1 1 Q, Quantity (MARKET) Quantity (FARM)

Equilibrium price is decided by the market at the intersection of supply S1 and Demand curve D1. Equilibrium Price P1 is then taken as given by the firms. Since At P1 = ATC, the firm is earnig normal profit as Profit= (P1-ATC)Q1

Point A is the breakeven level.

2.

Price I Price | mc B ATC ID=MR, D - Dy=MR, - ------ - D2 Q, Q2 Quantity Q,+Q2 Quantity (MARKET) (FARM)

Rise in demand leads to shift of DEMAND curve from D1 to D2.

New Equilibrium price rises from P1 to P2.

Equilibrium quantity rises from Q1 to Q2.

Firms now face a higher price level P2, Since the ATC and AVC and MC do not change, rise in price leads to positive economic profit.

Profit is the area of rectangle given by (P2-ATC)*Q2

Profits for the firm increases.

3. Due to the positive profits , many new firms will join the industry. This will lead to increase in supply, supply curve shifts right at the industry level.

4. In the long run, overall industry will be larger as new firms have joined the industry.

5. In the long run, when new firms will join the industry, it will drive down the price and the individual profit of the firm. Profits will fall back to the normal profit or zero profit level.

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