Perfect Competition

Department of Economics                                                          Prof. Andrew J. Buck

Temple University                                                                       Economics 3501

You will benefit greatly from either graph paper or some facility with EXCEL in completing this assignment.  Drawing the graphs will help you understand the dynamics of firm decisions. Your graphs will not be submitted and will not be graded, they are only meant to help you.

Name

A.  The Representative Catnip Firm in the Short Run

The catnip industry in Chatagonia is perfectly competitive.   Firms in the industry are identical and each has the following short run total cost function:

TC = 160.0 + 5.0q +  .025q2,

where q is tons produced per month.   Let P be the market price per ton.

A1.   Write the equation for the implied ATC function in the box below and carefully plot (Choose points at q = 20, 40, 60, 80, 100, 120, and 160.) this relationship on your piece of graph paper.

ATC =  /q + + q

A2.   Write the equation for the implied AVC function.  Plot this relationship in your graph.

AVC =   + q

A3.   Write the equation for the implied MC function.  Plot this relationship in your graph.

MC = + q

A4.   If  P = 13, how much does the representative firm produce per month?

q  =

A5.   What is its total revenue at this price and level of production?      TR =

A6.   What is its total cost at this price and level of production?        TC =

Denote with a “TC” the area in your graph that shows this cost.

A7.   What profit does it earn?  P = TR(q) - TC(q) =

Denote with a “P” the area in your graph that shows this profit.

A8.  At what price will the representative firm earn a zero profit? That is, what is its breakeven price?

Pbreakeven =

A9.  How much output is being produced at this price?  qbreakeven =

A10.  What loss will it incur if  P = 7.0?     Loss =

Denote with an “L” the area in your graph that shows this loss.

A11.  At P = 7.0 will the firm shutdown rather than incur this loss?  Yes      No

B.  The Catnip Industry in Initial Long Run Equilibrium

Initially, the catnip industry is in long run equilibrium.  Each firm in the industry has a U-shaped long run average cost curve which reaches a minimum value of  \$9.0 per ton at q = 80.  In addition, factor prices and production conditions are unaffected by the scale of the industry (i.e., there are no pecuniary or technological externalities).  These conditions tell us that catnip is a constant cost competitive industry.

On a new piece of graph paper plot the industry long run supply curve.

The industry demand function is Q = 5800 - 200P.  Plot this relationship in your graph.

B1.  Referring either to your graph or doing a bit of algebra from what you know about long run supply and industry demand, what are market price and quantity in the initial long run equilibrium?

P0 =                 Q0 =

In your graph label this point Eo.

B2.  How much output is each active firm producing (qo)?  How many active firms (No) are there in the industry

q0 =                    N0 =

B3.  What profit is each firm earning?     P0 =

C.  The Catnip Industry in Intermediate Short Run Equilibrium

Suppose now that the catnip market demand curve shifts outward so that 4,800 more tons per month are demanded at every price.  The equation for this new relationship is Q = 10,600 - 200P.  In the short run following this demand shift, industry production expands because the firms already in the industry increase their variable factors.   There is no increase in their fixed factors (i.e., plant and equipment) and no new firms enter the industry.

Plot the new demand function in your second graph.

The equation for the industry short run supply curve is Q = 1000P - 5000.   It was obtained by horizontally summing the individual supply curves (i.e., the MC curves) of the N0 active firms in the initial long run equilibrium.  Plot this relationship in your second graph.

C1.  What are market price and quantity in the intermediate short run equilibrium?  Use industry short run supply and the new demand curve.

P1 =           Q1 =

Label this equilibrium point E1in your second graph.

C2.  How much is each active firm producing (q1)?  How many active firms are there in the industry (N1)?

q1 =             N1 =

C3.  What profit is each firm earning?    (Hint: Use information from Part A.)

P1

D.  The Catnip Industry in Final Long Run Equilibrium

In the long run, the (economic) profits earned by the incumbent firms will attract new entrants into the industry until those profits disappear.

D1.    What are the market price and market quantity in the final long run equilibrium?

P2 =          Q2 =

In your second graph label this equilibrium point E2.

D2.  How much is each active firm producing?  How many active firms are there in the industry?

q2 =            N2 =

D3.  What profit is each firm earning?       P2 =