Problem Set 4 ECON

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```					ECON 10, Spring 2005
John F. Stewart
Problem Set #4
Perfect Competition

This problem set includes material from Chapter 8 and 9 and completes the material for the first exam.

Key Terms:

Perfect Competition                         Economic Profits                      Short run competitive equilibrium

Optimal Output rule                             entry/exit                        Long run competitive equilibrium

You should understand:

1) How a competitive firm decides how much output to produce.
2) The structural assumptions of a perfectly competitive market.
3) How price and output get determined in competitive markets in both the short and long run.

Part A:
Using the cost curves that you derived in Part B of Problem Set 3,

1) If the market price of bikes is \$500, how many would this firm decide to supply if it behaved in a profit maximizing
fashion? How many bikes would the firm decide to supply at each price shown in the table below?

At market price of: (dollars)                                   200          250      300      350        400       450      500

The firm will supply:

2) What happens to the optimal quantity supplied if the fixed costs increase by \$300 (decrease by \$300). What
happens to total revenue, total cost and profit?

3) At what price will the bicycle firm decide to “shut down”?

4) At what price will the bicycle firm “break even”? How many bicycles will it be producing?

PART B: Short and Long Run Perfectly Competitive Market equilibria (See the online tutorial to work through
problems like this.)

Figure 1 shows the
market demand and
Typical Firm                                       Market
supply wooden toy
\$             MC                       \$
trains. The market for                                                                        Supply1000
wooden toy trains is                                        AC
perfectly competitive.           \$5                                      \$5
Quantities are
\$3                                      \$3                                         Demand
measured in number of
trains per month.                \$1                                      \$1
There are currently
1000 firms supplying
the market. Also                      1      10 15               qfirm         1,000   10,000 15,000       20,000    50,000   Qmarket
shown in the diagram             Figure 1
are the average and marginal cost curves of a typical toy train firm. Assume that all firms in the market face identical
cost conditions and that there are no fixed inputs in toy train manufacturing. (Thus there is no difference between
long run and short run cost curves)

a) Given that there are currently 1000 firms operating in the market , What will be the short run competitive
equilibrium market price and quantity?

b) How many trains is each of the 1000 firms producing a month?

c) How much profit will each firm be making at the equilibrium described in parts a). and b).

d) In the long run, what do you expect to happen in this market? Why?

e) In the final long run market equilibrium, price (P) will be___ and the market quantity (Q) will be__

f) In the final long run equilibrium, there will be___ toy train firms each producing ___ trains per month.

g) In the final long run competitive market equilibrium, demonstrate to yourself that society can be made better off by
1) changing the quantity of toy trains produced, 2) change the number of firms or the output of firms, or 3) who gets
toy trains and who doesn’t.

Part C: Try questions 17-20 on Exam 1 Spring 2002.
Name____________________                                                                Econ 10-008 Spring 2005

Section Number____________                           Home Work Assignment 3             Pledge:_________________________

Instructions: Complete the following homework assignment to be turned in during your recitation section the week
of February 8. No late homework will be accepted and homework will only be accepted in the recitation section for
which you are registered.

Using the information and the graph from Part B of Problem Set 4,

Considering only the short run (when there are a total of 1000 firms in the market),

a) plot the short run equilibrium price (P1) market quantity (QM) and typical firm output (Q F) on the graph
below.
b) on the graph below show (and calculate) the total revenue that the typical firm will be making in the short
run equilibrium (Total Revenue = _____ ) , the total cost of the output produced by the firm (Total cost = _____ )
and the profits earned by the firm (Total profits= _______ ).

c) What is the shut down point in this market?______________________________

Typical Firm                                                 Market
\$                     MC                            \$
Supply1000
AC
\$5                                                   \$5

\$3                                                   \$3                                               Demand

\$1                                                   \$1

1         10 15                    qfirm         1,000      10,000 15,000          20,000       50,000        Qmarket

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