Question

2. In a perfectly competitive market, there are initially economic profits. Firm entry causes the market supply curve to shift rightwards, but the market does not reach its long run state. a. Draw two corresponding graphs, side-by-side, that allustrate this shift. One is the market supply and demand graph, and the other is the profit-maximizing production choice of a typical firm. Using your graph, explain b. How do price and marginal revenue change as firms enter c. How do MC and ATC change as firms enter? d. How do profits change for firms that were in the market all along? How do we know your graph, after the shift, is in the short run and not the long run? f Draw another graph, illuastrating the profit-maximizing production choice of a typical firm in the long run

Answer 1

Theory: Perfect competition has perfect information in the market. There are many sellers that sell a same type of product and all firms are price makers. any firm can easily enter or exit from the market. In the long run, firms will have normal profits as firms will easily enter if market is having abnormal profits or exit from the business if firms are making losses.

This is a perfect competition. Price = Demand = Average revenue = Marginal revenue.

Following are the conditions which should be considered.

When P > Average Total cost (ATC), the firm is making economic profit.

When P = minimum ATC, it is break even prices, the firm makes zero economic profit but earns normal profit.

When ATC > P > AVC(Average variable cost) the firm produces at a loss, but its loss is less than fixed costs; therefore, it continues to produce.

When P = minimum AVC, the firm’s loss = fixed costs; this P is the firm’s short-run shut-down price.

When P < AVC, i.e. when price falls below the shut-down price, the firm shuts down and stops producing.

Answers:

In the short run following figure can be assessed.

ATC, P. 2 P nee

a. Diagram made above.If firm is producing is at P2 and is having economic profit as Price > ATC.

b. As firms enter and Price aand margina revenue will go down.

c.MC and ATC will increase as new firms enter

d.firms will have reduced profit.

e. In the long run,normal profits will be stabilized and and these fluctuations will be staying in the short run.

f.Diagram is shown below where market will be stable at P2 and output Q2.

MC ATC ㄥ Yenen咚 rri 2. economi

e.