Suppose the market demand and supply functions are QD=1801.5PQD=1801.5P and QS=3

Question

Suppose the market demand and supply functions are QD=1801.5PQD=1801.5P   and QS=3.5P+40QS=3.5P+40. You have just graduated and moved to this city; as a new MBA and an entrepreneur, you are considering entering the market for this product.

P=$28P=$28; Q=138

1A.Given the new supply conditions QS=3.5P+10QS=3.5P+10, determine whether or not you should enter the market.

Select one:

a. Yes; the new equilibrium price is now between AVCAVC and ATCATC at the optimal quantity, so firms (including my new one) will earn loss but choose to stay open.

b. Yes; the new equilibrium price is slightly above ATCATC at the optimal quantity. If I entered I'd earn slightly above normal profit.

c. No; MCMC is above AVCAVC so I would not recoup my fixed costs.

d. No; the new equilibrium price is below AVCAVC so if I entered I would have to immediately shut down.

2B.Due to unforeseen delays, you don’t enter the market. However, a year later the market supply has changed to QS=3.5P+10QS=3.5P+10. Are you surprised at this shift in supply?

a. No; the profits that occurred in the previous question suggest that new firms would enter. This entry would shift supply right, which is what the new supply curve did.

b. Yes; the earlier profits should have caused mergers among firms, reducing the number of suppliers and thus supply itself (curve should shift left), though the new supply curve has actually increased (shifted right).

c. No; the losses incurred under the old supply curve would cause some sellers to exit, shifting supply to the left (which is what this new supply curve did).

d. Yes; the losses earned earlier should have reduced supply whereas this new equation shows an increase in supply.

Explanation / Answer

Demand: Qd = 180 – 1.5P; Supply: Qs = 3.5P + 40; New supply: Qs = 3.5P + 10.

P = $28; Q = 138.

To find the new equilibrium output and price.

180 – 1.5P = 3.5P + 10

5P = 170

P = $34. (Price above equilibrium price)

Q = 180 – (3*34)

Q = 78.

b. Yes; the new equilibrium price is slightly above ATC at the optimal quantity. If I entered I’d earn slightly above normal profit.

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