Chapter 9

Q. The bolt-making industry currently consists of 20 producers, all of whom operate

with the identical short-run total cost curve STC(Q) = 16 + Q2, where Q is the annual
output of a firm. The corresponding short-run marginal cost curve is SMC(Q) = 2Q. The
market demand curve for bolts is D(P) = 110 − P, where P is the market price.
a) Assuming that all of each firm’s $16 fixed cost is sunk, what is a firm’s short-run
supply curve?
b) What is the short-run market supply curve?
c) Determine the short-run equilibrium price and quantity in this industry.

a) First, find the minimum of AVC by setting AVC = SMC .

TVC Q 2
AVC = =
Q Q
AVC = Q

Q = 2Q
Q=0

The minimum level of AVC is thus 0. When the price is 0 the firm will produce 0, and for
prices above 0 find supply by setting P = SMC .
P = 2Q
Q = 12 P

Thus,
s ( P ) = 12 P

b) Market supply is found by horizontally summing the supply curves of the individual
firms. Since there are 20 identical producers in this market, market supply is given by
S ( P ) = 20 s ( P )
S ( P ) = 10 P

c) Equilibrium price and quantity occur at the point where S ( P) = D( P) .

10 P = 110 − P
P = 10

Substituting P = 10 back into D( P) implies equilibrium quantity is Q = 100 . So at the

equilibrium, P = 10 and Q = 100 .
Q. Newsprint (the paper used for newspapers) is produced in a perfectly competitive
market. Each identical firm has a total variable cost TVC(Q) = 40Q + 0.5Q2, with an
associated marginal cost curve SMC(Q) = 40 + Q. A firm’s fixed cost is entirely nonsunk
and equal to 50.
a) Calculate the price below which the firm will not produce any output in the short
run.
b) Assume that there are 12 identical firms in this industry. Currently, the market
demand for newsprint is D(P) = 360 − 2P, where D(P) is the quantity consumed in the
market when the price is P. What is the short-run equilibrium price?

a) The firm will not produce any output when the price falls below the point where SMC
= ANSC, i.e. the minimum of the ANSC curve. (Absence of sunk fixed cost here
can be seen as no fixed costs where there is no non-sunk fixed cost given.)

Therefore 50 / Q + 40 + 0.5Q = 40 + Q
This implies Q = 10. The corresponding price, below which the firms will not produce, is
equal to MC(10) = ANSC(10) = 50.

b) Each firm will produce according to the relation, P = MC, or P = 40 + Q . This means
that each firm’s supply curve is Q = P − 40 if P > 50 and zero if P < 50. Therefore market
supply equals 12( P − 40) and in equilibrium this must equal market demand, 360 − 2 P .
Therefore the equilibrium price is P = 60. At this price, each firm produces 20 units of
output. The firm’s profit is PQ − V (Q) − F and this equals 30. Substituting Q = 20 and P =
60, we get total fixed costs, F = 170. Since non-sunk fixed costs are 50, sunk fixed costs must
total up to 120.

Q. There are currently 10 identical firms in the perfectly competitive gadget

manufacturing industry. Each firm operates in the short run with a total fixed cost of F
and total variable cost of 2Q2, where Q is the number of gadgets produced by each firm.
The marginal cost for each firm is MC = 4Q. Each firm also has non sunk fixed costs of
128. Each firm would just break even (earn zero economic profit) if the market price
were 40. (Note: The equilibrium price is not necessarily 40 when there are 10 firms in
the market.)
The market demand for gadgets is QM = 180 − 2.5P, where QM is the amount purchased
in the entire market.
a) How large are the total fixed costs for each firm? Explain.
b) What would be the shutdown price for each firm? Explain.
c) Draw a graph of the short-run supply schedule for this firm. Label it clearly.
d) What is the equilibrium price when there are 10 firms currently in the market?
e) With the cost structure assumed for each firm in this problem, how many firms
would be in the market at an equilibrium in which every firm’s economic profits are
zero?

a) C = F + 2Q2. MC = 4Q.
Breakeven price = 40. When P = 40, the firm would produce Q so that MC = P; 40 = 4Q; Q =
10.
Profit = PQ – F – 2Q2 = 40(10) – F – 2(10)2 = 200 – F = 0. So F = 200.

b) The total nonsunk fixed cost is NSC = 128 + 2Q2 .

The firm will shut down if the market price is less than the minimum of ANSC. ANSC =
(128 + 2Q)2/Q.
At minimum of ANSC, we know that ANSC = MC, or that [128 + 2Q2]/Q = 4Q, so the
quantity at the shutdown price is Q = 8.
The shutdown price will be where Q = 8; MC = 4Q = 4(8) = 32. So the shutdown price is P =
32.
(Alternatively, you can verify that when Q = 8, then ANSC = 32.)

c) The firm’s supply schedule will be Q = 0 when P < 32.

When P > 32, the firm will supply according to the optimal quantity choice rule P = MC; thus
P = 4Q, so that Q = 4/P.
When P = 32, the firm will be indifferent between shutting down (Q = 0) or operating with Q
= 8.
P / 4 when P  32
To summarize, Q = 0 when P  32
0 or 8 when P = 32

d) With 10 firms in the market, total market supply will be 10(P/4) = 2.5P. Market
demand is 180 – 2.5P.
In equilibrium 2.5P = 180 – 2.5P, so P = 36 (note: P > 32, so the firms do produce).
e) For profits to be zero, the price would be P = 40, and each firm would produce
40/4 = 10 units.
The quantity demanded in the market would be 180 – 2.5(40) = 80 units. Thus, there is room
for only 80/10 = 8 firms.
Chapter 10

In a perfectly competitive market, the market demand curve is Qd = 10 − Pd, and the
market supply curve is Qs = 1.5Ps.
a) Verify that the market equilibrium price and quantity in the absence of government
intervention are Pd = Ps = 4 and Qd = Qs = 6.
b) Consider two possible government interventions: (1) A price ceiling of $1 per unit; (2)
a subsidy of $5 per unit paid to producers. Verify that the equilibrium market price
paid by consumers under the subsidy equals $1, the same as the price ceiling. Are the
quantities supplied and demanded the same under each government intervention?
c) How will consumer surplus differ in these different government interventions?
d) For which form of intervention will we expect the product to be purchased by
consumers with the highest willingness to pay?
e) Which government intervention results in the lower deadweight loss and why?

a) 10 – P = 1.5P  P = 4 and Q = 10 – 4 = 6.

b) Under a $5 subsidy paid to producer, market price P = Pd and the after-subsidy price
received by producers is Ps = Pd+5. Thus: 10 – P = 1.5(P + 5)  P = 1.

c) Consumer surplus under the subsidy will be greater than the consumer surplus under a
price ceiling. Under both interventions, consumers pay the same price, but under subsidies
consumers are supplied as much as they demand at the $1 market price, while under price
ceilings, consumers get less than they demand at the $1 ceiling price.

d) Subsidies. Under subsidies, because consumers get what they demand at the market
price, there is no possibility of consumers with a lower willingness to pay getting the good
while consumers with a higher willingness to pay do not get the good. This is a possibility
with a price ceiling.

e) The subsidy has the smaller deadweight loss. The deadweight loss under the price
ceiling (assuming efficient rationing) is area C+H+I, which equals 16.875. The deadweight
loss under the subsidy is area L, which equals 7.5.