Prof. Dr. Sebastian J.

Goerg Economics I Tutorial

Prof. Dr. Michael Kurschilgen

Solutions for Problem Set 10

Question 1 (Long term market equilibrium)
Given:

q 2 + 1, q>0
• Cost function: C(q) =
0, q=0

• Market demand: QD (p) = 52 − p

(a) In the long run, each company produces the quantity q ∗ , for p = M C(q ∗ ),
if M C(q ∗ ) ≥ AT C(q ∗ ).

• From the condition p = M C(q) it follows p = 2q ⇔ q = 21 p.

• From the condition M C(q) ≥ AT C(q) it follows 2q ≥ q + 1
q
⇔
q ≥ 1.
• For q ≥ 1 it follows p ≥ 2.
• Therefore the long term supply function of a company is

0, p < 2
qS (p) = 1
2
p, p ≥ 2.

⇒ Then, the long term market supply function for n companies is


0, p < 2
QS (p) = 1
2
np, p ≥ 2.

(b) In the long term market equilibrium, there are no incentives for com-
panies to enter or leave the market. This is the case, if the profits of
the companies which are active in the market are (close to) zero. The
profits are zero, if p = M C(q) = AT C(q).

• From the condition M C(q) = AT C(q) it follows that q = 1 ⇒

p = 2.
• Then, the market demand is QD (2) = 52 − 2 = 50.
• In the equilibrium, it is QD (p) = QS (p).
• From the equilibrium condition QD (2) = 50 = 21 n2 = QS (2) it
follows n = 50.
⇒ Therefore, there are 50 companies operating in the long run equi-
librium, and each one sells one unit of output for the price of 2.
Therefore, the equilibrium output of the entire industry is 50.

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Prof. Dr. Sebastian J. Goerg Economics I Tutorial
Prof. Dr. Michael Kurschilgen

(c) New market demand: QD (p) = 52, 5 − p.

• Zero profits imply that q = 1 ⇒ p = 2.

• Then, the market demand is QD (2) = 50, 5.
• From the equilibrium condition QD (2) = 50, 5 = 21 n2 = QS (2) it
follows that n = 50, 5.
• In order to make zero profits, there would have to be 50, 5 com-
panies in the market. Since companies can naturally just exist in
natural numbers, there have to be either 50 or 51 companies in
the market.
(i) For 51 companies in the market, the equilibrium condition
is QD (p) = 52, 5 − p = 12 51p = QS (p). Therefore it follows
p ≈ 1, 98 < 2. All 51 companies would make losses. Hence,
there can’t be 51 companies in the market in the long run.
(ii) For 50 companies in the market, the equilibrium condition
is QD (p) = 52, 5 − p = 21 50p = QS (p). Therefore it follows
p ≈ 2, 02 > 2. All 50 companies make profits. However, no
new company enters the market, since if there would be 51
companies, the market price would fall under 2 and all 51
companies would make losses.
⇒ In the long run equilibrium, there are 50 companies operating in
the market, which all produce 1, 01 output units each, for a price
of 2, 02 and make a profit of:

π(1, 01) ≈ 2, 02 · 1, 01 − (1, 012 + 1) ≈ 0, 02

(d) New market demand: QD (p) = 53 − p.

• Zero profits imply q = 1 ⇒ p = 2.

• Then, the market demand is QD (2) = 51.
• From the equilibrium condition QD (2) = 51 = 21 n2 = QS (2) it
follows that n = 51.
⇒ Therefore, there are 51 companies operating in the long run equi-
librium and each one produces one unit of output for the price of
2 and makes zero profits.

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Prof. Dr. Sebastian J. Goerg Economics I Tutorial
Prof. Dr. Michael Kurschilgen

Question 2 (Mechanics of the market)

QD = 80 − 10P + 0, 01M − 2R
QS = −200 + 40P

(a) Given: M = 25.000, R = 40

→ QaD = 80 − 10P + 250 − 80 = 250 − 10P
!
EQM-condition: QS = QaD
40P − 200 = 250 − 10P
50P = 450
P∗ = 9
Q∗ = 250 − 10 · 9 = 160

⇒ P ∗ = 9; Q∗ = 160

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Prof. Dr. Sebastian J. Goerg Economics I Tutorial
Prof. Dr. Michael Kurschilgen

(b) Given: M = 25.000, R = 15

→ QbD = 80 − 10P + 250 − 30 = 300 − 10P

Price P
30

25

20

15
QS
P̂ * 10

5
QDb
P* QDa
20 40 60 80 100 120 140 160 180 200 220 240 260 280 300 Quantity Q
Q* Q̂ *

Fewer rainy days lead to an increasing demand for drinks. The de-
mand curve shifts to the right (see graphic). In comparison to the old
price P ∗ = 9, there’s an excess demand for drinks now. Therefore, the
market price increases to P̂ ∗ and the quantity increases to Q̂∗ (new
equilibrium).
!
EQM-condition: QS = QbD
40P − 200 = 300 − 10P
50P = 500
P̂ ∗ = 10
Q̂∗ = 300 − 10 · 10 = 200

The new equilibrium price is 10, the new equilibrium quantity is 200.

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Prof. Dr. Sebastian J. Goerg Economics I Tutorial
Prof. Dr. Michael Kurschilgen

(c) Calculating the price elasticity:

P dQ P
ηP = · = · Q0 (P )
Q |{z}
dP Q
Q0 (P )

Economic interpretation: ηP is the percentage change of quantity due

to a price increase of prices by 1%. ηP is a local measure. ηPD (ηPS ) is
the responsiveness of demand (supply) for a marginal change in prices.
Since dQ
dP
D
< 0 ( dQ
dP
S
> 0) it is ηPD < 0 (ηPS > 0).

The price elasticity of demand/supply in the market equilibrium (part

b):

P̂ ∗ dQD 10
ηPD = Q̂∗
· dP
= 200
· (−10) = − 12 <0
P̂ ∗ dQS 10
ηPS = Q̂∗
· dP
= 200
· 40 = 2 >0

Note: The supply/demand is said to be price elastic, if the relativ

change in quantity is higher than the relativ change in prices (|ηP | > 1).

Here: |ηPD | < 1 ⇒ demand is price inelastic

|ηPS | > 1 ⇒ supply is price elastic