Suppose you are given the following information about a particular PERFECTLY COM
ID: 2495502 • Letter: S
Question
Suppose you are given the following information about a particular PERFECTLY COMPETITIVE INDUSTRY:
The market demand curve is Q = 6500 - 100P
The market supply curve is Q = 1200P
You are also given the following information about a single PERFECTLY COMPETITIVE FIRM that operates in this industry:
The total cost function for the firm is TC = 722 + (Q^2 /200)
The marginal cost for the firm is MC = (2Q/200)
a. Calculate the profit-maximizing level of output for the individual firm and the price they charge.
b. Would you expect to see entry into or exit from this industry in the long-run? EXPLAIN YOUR REASONING. In addition, CALCULATE the price at which entry into or exit from the industry will stop.
c. Clearly explain why firms will continue to remain in the industry even when economic profits are driven to zero in the longrun.
Explanation / Answer
a. Calculate the profit-maximizing level of output for the individual firm and the price they charge.
Equilibrium price and quantity are found by setting market supply equal to market demand, so
that 6500-100P=1200P. Solve to find P=5 and substitute into either equation to find Q=6000.
To find the output for the firm set price equal to marginal cost so that 5 =
2q/200
and q=500.
Profit of the firm is total revenue minus total cost or
= pq C(q) = 5(500) 722
500^2/200
= 528. Notice that since the total output in the
market is 6000, and the firm output is 500, there must be 6000/500=12 firms in the industry.
Would you expect to see entry into or exit from this industry in the long-run? EXPLAIN YOUR REASONING. In addition, CALCULATE the price at which entry into or exit from the industry will stop.
Answer
Entry because the firms in the industry are making positive profit. As firms enter, the supply
curve for the industry will shift down and to the right and the equilibrium price will fall, all
else the same. This will reduce each firm’s profit down to zero until there is no incentive for
further entry.
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