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Competition Problem #5 Answers (
(1)
points)
Open the Competition module of SimEcon®. You will the “Firm’s Short
Run Costs.” Print out this table or copy the information. Click “Continue”
and set the market price of the product manually at $12.00. Now select
“Choose Output” and set output at 8,000 units. Click “Results.” Now write
a paragraph that analyzes this firm’s situation. Should the firm increase
production, decrease production or leave production unchanged? Explain
your answer using marginal analysis. Determine whether the firm should
shut down or not, based on the market price and the firm’s variable cost.
Finally, explain whether the firm is earning an economic profit or loss.
At an output of 8,000 units, price, which equals marginal revenue, is greater than
marginal cost. The price is $12.00 and the marginal cost is $5.60. The firm can increase
profits by increasing output by at least one unit because the next unit produced will
generate $12.00 in revenue and only $5.60 in additional costs. The price ($12.00) is
greater than average variable cost ($7.20), so the monopolist does not need to shut down.
The price ($12.00) is also greater than average total cost ($9.20), which means that the
monopolist is earning above normal profits. Above normal profits are equivalent to
economic profits.
Draw a graph of this firm’s current situation. Include the graph of the
market supply and demand and the graph of the situation faced by the
individual firm. Show the individual firm’s demand curve, average total cost
curve, average variable cost curve, and the profit maximizing output on this
graph. Is the industry this firm is in now in long run competitive
equilibrium? Why or why not?
$
Note: Q* = Current Output; Q** = Optimal Output.
$
MC
ATC
AVC
S
P = MR = AR
SLR
D
Q*
Q**
FIRM
Q
Q
MARKET
The firm is not in long run competitive equilibrium because 1) as indicated by the right
hand graph the firm is producing at a point that is below optimal at the current price; and
2) the whole market is in short run equilibrium since supply equals demand, but not in
long run equilibrium since there are positive economic profits.
(2)
Click “New Output.” Enter an output of 12,000 units and click “Results”
and analyze this firm’s new situation. Should the firm increase production,
decrease production or leave production unchanged? Explain your answer
using marginal analysis. Also, explain whether the firm should shut down or
not, based on the market price and the firm’s variable cost. Finally, explain
whether the firm is earning an economic profit or loss.
At an output of 12,000 units, price, which equals marginal revenue, is less than marginal
cost. The price is $12.00 and the marginal cost is $37.60 so the firm can increase profits
(or reduce losses) by lowering output by at least one unit. This is because the last unit
produced generated $12.00 in revenue and $37.60 in additional costs. The price ($12.00)
is greater than average variable cost ($11.20), so the monopolist does not need to shut
down. The price ($12.00) is less than average total cost ($12.54), which means that the
monopolist is earning below normal profits. Below normal profits are equivalent to an
economic loss.
(3)
Click “New Price” and reset the market price at $7.00. Now “Choose
Output” and select an output of 8,000 units. Click “Results.” Write another
paragraph that analyzes this firm’s situation. Should the firm increase
production, decrease production, or leave production unchanged? Explain
your answer using marginal analysis. Explain whether the firm should shut
down or not, based on the market price and the firm’s variable cost. Finally,
explain whether the firm is earning an economic profit or loss.
At an output of 8,000 units, price, which equals marginal revenue, is greater than
marginal cost. The price is $7.00 and the marginal cost is $5.60 so the firm can reduce
losses by increasing output by at least one unit. This is because the last unit produced
generated $7.00 in revenue and $5.60 in additional costs. However, the price ($7.00) is
less than average variable cost ($7.20), so the firm would be better of shutting down than
doing what it is doing. It is not clear from this if the firm’s best move is to shut down,
since it is not clear that the minimum value for average variable cost is less than $7.00.
(4)
Click “New Price” and reset the market price at $9.05. Now “Choose
Output” and select an output of 8,688 units. Click “Results.” Write another
paragraph that analyzes this firm’s situation. Should the firm increase
production, decrease production or leave production unchanged? Explain
your answer using marginal analysis. Also, explain whether the firm should
shut down or not, based on the market price and the firm’s variable cost.
Finally, explain whether the firm is earning an economic profit or loss.
At an output of 8,688 units, price, which equals marginal revenue, is approximately equal
to marginal cost. The price is $9.05 and the marginal cost is $9.05. Thus, the firm is
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operating at an optimal point since the last unit produced generated $9.05 in revenue and
approximately $9.05 in additional costs. The price ($9.05) is greater than average
variable cost ($7.20), so the firm does not need to shut down. The price ($9.05) is equal
to average total cost ($9.05), which means that the firm is earning normal profits. This
means that the accounting profit generated by his/her firm produces a normal rate of
return compared to other uses of the firm owner’s time and money.
Draw a graph of this firm’s current situation. Include the graph of the
market supply and demand and the graph of the situation faced by the
individual firm. Show the individual firm’s demand curve, average total cost
curve, average variable cost curve, and the profit maximizing output on this
graph.
Note: Q* = Current Output and Optimal Output
$
$
MC
ATC
AVC
S
SLR
P = MR = AR
D
Q*
FIRM
Q
Q
MARKET
Is this firm in long run competitive equilibrium? Is the industry in long run
equilibrium? Why or why not? Other things being equal, (assuming that
there are no shocks to the system), will this situation remain the same? Why
or why not?
Yes, this firm is in long run competitive equilibrium. The marginal cost curve crosses the
price line at the minimum point on the average total cost curve. The firm is earning
exactly normal profits given the opportunity costs of her/his inputs and given what other
firms are earning in other industries. This firm can succeed in earning normal profits
only by operating at the minimum possible average total cost and by producing the output
where marginal cost equals price. There is no incentive to increase or decrease output.
Likewise, there is no incentive for firms to enter or leave the industry. Thus, this
situation will remain constant until there is a shock to the system, e.g., one of the ceteris
paribus conditions changes, such as consumer tastes and preferences.
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