Question

Assume that you are employed as an analyst at an international consulting firm. Your latest assignment is to do an industry analysis of the fast-growing "telemonica" industry. After extensive research on this combination cell phone and harmonica, you have obtained the following information: • • Long-run costs: Capital costs: $40 per unit of output Labor costs: $25 per unit of output ¦ No economies or diseconomies of scale ¦ Industry currently earning a normal return to capital (profit of zero) ¦ Industry perfectly competitive, with each of 100 firms producing the same amount of output ¦ Total industry output: 800,000 telemonicas. Demand for telemonicas is expected to grow rapidly over the next few years, especially in foreign markets, to a level four times as high as it is now, but (due to short-run diminishing returns) each of the 100 existing firms is likely to be producing only 100 percent more. a. Sketch the long-run cost curve of a representative firm. b. Show the current conditions by drawing two diagrams, one showing the industry and one showing a representative firm. c. Sketch the increase in demand and show how the industry is likely to respond in the short run and in the long run.

Answer 1

Diagram for the Firm :

where

LRAC : Long Run average Cost Curve

SRAC : Short Run Average Cost Curve

SRMC : Short Range Marginal Cost Curve

Diagram for the Industry :

Blue : Demand Curve

Red : Supply Curve