ECON111
Tutorial 10
Week 12
Question 1.a
• Explain why the demand curve in a perfectly
competitive market is downward sloping,
while the demand curve of an individual firm
in a perfectly competitive market is perfectly
elastic?
1. The intersection of the market supply
and the market demand curve…
Price per
Ounce
Market
3. The typical firm can sell all it
wants at the market price…
Price per
Ounce
Firm
S
$400
$400
D
Ounces of Gold per Day
2. determine the equilibrium
market price
Demand
Curve Facing
the Firm
Ounces of Gold per Day
4. so it faces a horizontal
demand curve
Question 1.b
Total revenue is a straight line up to the right.
Its slope is constant – it is a straight line – because marginal revenue is constant.
Marginal revenue is constant under perfect competition because additional
units can be sold at a constant price
TR
1400
1200
1000
800
TR = P x Q
600
MR
400
200
0
0
2
4
6
8
10
12
Q
P = $125
Q
TR = P x Q
0
0
1
125
2
250
3
375
4
500
5
625
6
750
7
875
8
1000
9
1125
10
1250
MR
125
125
125
125
125
125
125
125
125
125
Question 1.c
Profit Determination Using Total Cost and Revenue Curves
Total cost, revenue
TC
$385
350
315
280
245
210
175
140
105
70
35
0
TR
Loss
Maximum profit =$81
Profit
$130
Loss
1 2 3 4 5 6 7 8 9
Quantity
Profit is maximized where the vertical distance between total revenue and total cost is greatest.
At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal
Question 2.a
Market
P
3.65
5.20
6.80
8.40
10.00
11.60
13.20
Q demanded
500,000
450,000
400,000
350,000
300,000
250,000
200,000
Individual Firm
(1,000 firms)
Q produced
MC
200
6.40
250
7.00
300
7.65
350
8.40
400
10.00
450
12.40
500
20.70
Market equilibrium Qd = Qs
When P = $8.4
Qd = 350,000 boxes
Qs = 350 X 1,000 = 350,000 boxes
AVC
7.80
7.00
7.10
7.20
7.50
8.00
9.00
ATC
12.80
11.00
10.43
10.06
10.00
10.22
11.00
Market equilibrium Qd = Qs
When P = $8.4
Qd = 350,000 boxes
Qs = 350 X 1,000 = 350,000 boxes
Question 2.b
When P = $8.4 per box
AVC = $7.20
ATC = $10.06
P > AVC
Firm can cover fixed costs and some
variable costs
8.4
P < ATC
Firm incurs an economic loss
Loss per unit
ATC – P = $10.06 - $8.4 = $1.66
Total loss
(ATC – P) × Q = $1.66 × 350 = $581
Question 2.c, d
•
In the long run some firms exit the market because they are incurring an
economic loss, as such P = ATC.
Market
P
3.65
5.20
6.80
8.40
10.00
11.60
13.20
•
•
•
•
Q demanded
500,000
450,000
400,000
350,000
300,000
250,000
200,000
Individual Firm
Q produced MC
200
6.40
250
7.00
300
7.65
350
8.40
400
10.00
450
12.40
500
20.70
AVC
7.80
7.00
7.10
7.20
7.50
8.00
9.00
ATC
12.80
11.00
10.43
10.06
10.00
10.22
11.00
When P = ATC, P = $10
Qd = 300,000 boxes
While each firm produces 400 boxes
So there are 300,000/400 = 750 firms in the market (industry)
Question 3
• Explain and illustrate graphically how the growing
world population is influencing the world market
for wheat and a representative individual wheat
farmer.
– Increase in world population increases the market
demand for wheat.
– The price of wheat increases and, hence, existing
farmers make an economic profit
– This attracts entry by new farmers which increases
supply, lower the price, and eliminate economic
profit.
B
A
C
Initial equilibrium is at A, demand and supply are D0 and S0, where P = $4, Q = 15,000,000
As world population increases, the market demand increases, the demand shifts right to D1
At B, the price increases to P = 5, hence MR = P increases from MR0 to MR1
Each firms responds by increasing output to Q = 225,000
Now, firms are making economic profit since P > ATC
Economic profit attracts entry by new firms, leading to an increase in supply, from S1 to S1
Hence, at C, the market price falls back to the initial price P = $4, MR falls back to MR0
each produces Q = 200,000
The market equilibrium quantity is Q = 25,000,000
The firms now make zero economic profit and there is no longer an incentive for new entry.