Question

18 pts Question 1 Refer to Question 2 of Homework 6. Consider a competitive market in which the market demand for the product is expressed as: P = 86- 0.0004Q, and the supply of the product is expressed as: P-6+ 0.00060. The typical form in this market has a marginal cost of MC = 6 + 0.969. c. If the market demand were to increase to P-90 -0.0004Q, what would the new price and output in the market be in the short-run? What would the new output for the typical firm be? (2+2 - 4 points) d. If the original equilibrium given in (a) represented a long-run equilibrium condition in the market (assuming constant cost industry), would the new equilibrium in (c) represent a new long-run equilibrium for the typical firm? Explain. (2+2 - 4 points) e. To be in the long-run equilibrium with the new demand, how many firms would enter into or leave from the Industry? Show your work. (2+8 - 10 points)

Answer 1

c)

New demand function is given by

P=90-0.0004Q

Supply function is given by

P=6+0.0006Q

In equilibrium

90-0.0004Q=6+0.0006Q

84=0.001Q

Q=84000

P=90-0.0004*84000=56.40

New Price=$56.40

New output=84000 units

Output of each firm can be determined by setting MC=P

6+0.96q=56.40

0.96q=50.40

q=50.4/0.96=52.50 units

Output of individual firm=52.50 units

d)

In case of perfect competition, minimum average cost is long run equilibrium price. Since cost structure of a firm is same. New demand curve will not affect long run equilibrium price.

Hence, new price will not be a new long run price.

e)

Since price has increased in short run, profit of firm would increase and hence more firms would enter into market.

For calculating the number of firms in initial situation,set initial demand equal to supply.

86-0.0004Q=6+0.0006Q

80=0.001Q

Q=80/0.001=80000

P=86-0.0004*80000=$54

Set MC=P to determine the output of an individual firm.

6+0.96q=54

0.96q=48

q=48/0.96=50 units

Number of firms =Desired output/output of a firm=80000/50=1600

To be in long run equilibrium, price should be equal to minimum ATC i.e. price in initial situation. So, New long run equilibrium price should be $54

Quantity demanded in new situation at a price of $54 can be determined by using new demand curve

P=90-0.0004

54=90-0.0004Q

Q=(90-54)/0.0004=90000

Number of firms in new long run=Desired output/output of a firm=90000/50=1800

Number of firms that should enter into market=1800-1600=200