Mr. Maurer
AP Economics
Name: ________________________
Chapter 23, Problem Set 1
Perfect Competition
Refer to the graphs above for questions #1 and 2.
1. Suppose the short-run industry supply curve is given by S1.
a. Identify the short-run equilibrium market price and quantity. _____P1 and Q5______
b. What quantity will the representative firm produce at this price? ___Q4____________
c. Is this firm making positive, zero, or negative economic profit (loss) at this price?
Positive economic profit (MR > ATC)
d. Holding everything else constant, what will happen in the long run in this industry?
Identify the long-run equilibrium price and quantity in the industry.
In the long run, new firms will enter this industry, increasing supply, and decreasing
equilibrium price. The long-run equilibrium price will be P2 because that is the minimum ATC
for a representative firm (and therefore every firm) in the industry. At P2, the equilibrium
quantity in the industry will be Q6.
e. Holding everything else constant, identify the quantity produced by the firm in the
long-run and the level of profit for the firm in the long run.
In the long-run, the firm will produce Q3 (that’s where P2 intersects MC). The firm will
make a normal profit because price = average total cost.
2. Assume that this representative firm is currently experiencing losses in the short-run, but that
it is covering all of its variable costs and some of its fixed costs. Given the price choices in the
graphs above, what is the current price for this good? In the long-run, will there be entry of new
firms into the industry, or will existing firms leave the industry?
Price must be P3 because it is the only price below ATC (firms is experiencing losses), but above AVC
(firm is covering some of its fixed costs). In the long-run, existing firms will leave the industry due to
losses.
3. A.P. Milk is a typical profit-maximizing company in a perfectly competitive industry that is in long-run
equilibrium.
a. At the bottom of this page, draw correctly labeled side-by-side graphs for the dairy market and
for A.P. Milk and show each of the following: (See Figure 23.7 on p. 426 and 23.8 on p. 428)
i. Price and output for the industry.
ii. Price and output for A.P. Milk.
b. Assume that milk is a normal good and that consumer income falls. Assume that A.P. Milk
continues to produce. On your graphs, show the effect of the decrease in consumer income on each of the
following in the short-run.
i. Price and output for the industry.
ii. Price and output for A.P. Milk.
iii. Area of loss or profit for A.P. Milk.
c. Following the decrease in consumer income, what must be true if A.P. milk is to continue to
produce in the short-run?
The new price (P2) must be greater than AVC at the new quantity (Q3).
d. Assume that the industry adjusts to a new long-run equilibrium. Compare the following
between the initial and the new long-run equilibrium.
i. Price in the industry. Will return to the old equilibrium (Pe).
ii. Output for a typical firm. Will return to original quantity (Qe)
iii. The number of firms in the dairy industry. There will be fewer firms in the industry
due to the exit of firms because of losses. Therefore, fewer firms will each produce the same
quantity per firm, but the total output for the industry will go down.
4. Mr. Maurer finally left teaching to open his own business. He produces DVD movies for sale, which
requires only a building and a machine that copies the original movie onto a DVD. Mr. Maurer rents a
building for $10,000 per month and rents a machine for $10,000 a month. Those are his fixed costs. His
variable cost is given in the accompanying table. (You can ignore any implicit or opportunity costs not
given). Assume that the market for DVDs is perfectly competitive, is in long-run equilibrium, and that the
market price of a DVD is currently $14.83.
Quantity of
DVDs
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Total
Fixed Cost
Total Variable
Cost
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
Total Cost
0
10,000
18,000
25,000
34,000
48,000
68,000
96,000
133,000
Average
Variable Cost
20,000
30,000
38,000
45,000
54,000
68,000
88,000
116,000
153,000
10.00
9.00
8.33
8.50
9.60
11.33
13.71
16.63
Average
Total
Cost
Marginal
Cost
30.00
19.00
15.00
13.50
13.60
14.67
16.57
19.13
10.00
8.00
7.00
9.00
14.00
20.00
28.00
37.00
a. In the space below, draw side-by-side diagrams for Mr. Maurer’s firm and for the entire industry.
Illustrate on the appropriate diagram:
i. the industry supply curve, demand curve, and market price
ii. Mr. Maurer’s marginal revenue curve, short-run supply curve, average total cost curve and
average variable cost curve. Note: you do not need to graph these perfectly with the numbers above. Just
put in the proper shapes and maintain the proper relationships between them. Then you just need to
identify a few key points on your graphs.
b. At the current market price, what is Mr. Maurer’s profit-maximizing output? Indicate on the diagram.
5000 units – see diagram.
c. What is Mr. Maurer’s shut-down price in the short run? Indicate this on the diagram.
$8.33 – See diagram.
d. At the current market price, how much economic profit is Mr. Maurer making?
Profit = (Price – ATC) x Quantity = (14.83 – 13.60) x 5000 = $6150.
Mr. Maurer
20.50
DVD Industry
20.50
14.83
13.50
14.83
13.50
8.33
6000
S2
5. Now assume that consumer incomes rise and DVDs are a normal good, causing the price of DVDs to
rise to $20.50.
a. Indicate the effect of this change on your graph of the industry. See Diagram
b. What is Mr. Maurer’s new profit-maximizing quantity? Indicate on the diagram.
6000 units
c. What is Mr. Maurer’s new economic profit? Show your computations.
(20.50 – 14.67) x 6000 = $34,980
d. In the long-run, how will the industry respond to this change? Explain and indicate this
response on your diagram of the industry.
New firms will enter the industry because economic profits are possible because price is higher
than ATC for the typical firm. This will shift the supply curve to the right.
e. What will be the long-run equilibrium price for DVDs?
$13.50