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Supply in a Competitive Market Chapter 8 99
1. a. Organic onion farming is most likely to be perfectly competitive, because there are a large number of firms sell-
ing an identical product in an industry without barriers to entry. Aluminum production is an industry with a small
number of dominant producers, and the need for access to key raw materials can be a barrier to entry. Because
cars are differentiated between producers, the automobile industry does not qualify as one in which products are
identical.
b. Perfect competition is the most straightforward industry structure, and it serves as a benchmark for comparison
when measuring the efficiency of other markets. Also, many industries are close enough to perfect competition
that the model of perfect competition makes accurate predictions of how these firms will behave.
2. Assume that soybean production is perfectly competitive. When we study the behavior of the firm, we assume that
the demand faced by that firm is perfectly elastic. Yet in the marketplace, demand may be highly inelastic. Drawing
on the determinants of the elasticity of demand outlined in chapter 2, resolve this apparent paradox.
2. The number of available substitutes is a key determinant for the elasticity of demand. Although there may not be a
lot of substitutes for soybeans, there are many substitutes for soybeans from any one individual producer. The more
narrowly the product is defined, the greater the elasticity due to more substitutes being available.
*3. Nancy sells beeswax in a perfectly competitive market for $50 per pound. Nancy’s fixed costs are $15, and Nancy is
capable of producing up to 6 pounds of beeswax each year.
a. Use that information to fill in the table below. (Hint: Total variable cost is simply the sum of the marginal costs up
to any particular quantity of output!)
0 0 15 — —
1 30
2 35
3 42
4 50
5 60
6 72
b. If Nancy is interested in maximizing her total revenue, how many pounds of beeswax should she produce?
c. What quantity of beeswax should Nancy produce in order to maximize her profit?
d. At the profit-maximizing level of output, how do marginal revenue and marginal cost compare?
99
e. Suppose that Nancy’s fixed cost suddenly rises to $30. How should Nancy alter her production to account for this
sudden increase in cost?
f. Suppose that the bee’s union bargains for higher wages, making the marginal cost of producing beeswax rise by
$8 at every level of output. How should Nancy alter her production to account for this sudden increase in cost?
3. a.
Total Fixed Variable Total Marginal Marginal
Quantity Revenue Cost Cost Cost Profit Revenue Cost
0 0 15 0 15 –15 — —
1 50 15 38 53 –3 50 38
2 100 15 81 96 4 50 43
4. The egg industry comprises many firms producing an identical product. Supply and demand conditions are indicated
in the left-hand panel of the figure below; the long-run cost curves of a representative egg producer are shown in
the right-hand panel. Currently, the market price of eggs is $2 per dozen, and at that price consumers are purchasing
800,000 dozen eggs per day.
1.50 1.50
1 1
0.50 0.50
D
0 800 1,200 1,600 2,000 2,400 0 1,000 2,000 2,300 2,400
Quantity (thousands of dozens) Quantity (dozens)
a. Determine how many eggs each firm in the industry will produce if it wants to maximize profit.
b. How many firms are currently serving the industry?
c. In the long run, what will the equilibrium price of eggs be? Explain your reasoning, and illustrate your reasoning
by altering the graphs above.
d. In the long run, how many eggs will the typical firm produce?
e. In the long run, how many firms will comprise the industry?
4. a. Since firms will produce where MR = MC, the representative firm in the industry will produce 2,400 dozen eggs.
b. The market demand is 800,000 dozen eggs at a price of $2. At the same time, each firm produces
2,400 dozens of eggs. Therefore, the number of firms serving the industry is
800,000
_ ≈ 333
2,400
c. The long-run equilibrium price of eggs will be $1, which equals the minimum of the LATC curve, the point at
which firms earn zero profit (P = LATC = MC ).
1.50 1.50
1 1
0.50 0.50
D
0 800 1,200 1,600 2,000 2,400 0 1,000 2,000 2,300 2,400
Quantity (thousands of dozens) Quantity (dozens)
d. In the long run, the typical firm will produce 2,000 dozen eggs.
e. In the long run, at a market price of $1, the market demand is 1,600,000 dozens of eggs. Each firm
1,600,000
produces 2,000 dozen. Hence, there will be _ = 800 firms in the industry.
2,000
5. The diagram on the right depicts the revenues and costs of a Firm TC
firm producing vodka. revenue
a. Why is total revenue represented as a straight line in- & cost ($) TR
stead of a curve? What assumption of perfect competi-
tion does that linearity reflect?
b. What will the firm’s profit be if it decides to produce
20 units of output? 120 units?
c. Suppose the firm is producing 70 units of output and de-
cides to cut output to 60. What will happen to the firm’s
profit as a result? 0 20 70 120 Quantity
d. Suppose the firm is producing 70 units of output and decides
to increase output to 80. What will happen to the firm’s profit as a result?
e. At an output level of 70, draw a line tangent to the total cost curve. Does your line look similar to the total
revenue curve? What does the slope of the total revenue curve indicate? What does the slope of the total cost
curve indicate?
5. a. Total Revenue = Price × Quantity. Because price is constant, the total revenue function has a constant slope. Each
firm in perfect competition is a small part of the market, and so it can increase the quantity it brings to the market
without creating any downward pressure on price.
b. At both production levels, 20 and 120 units of vodka, the profit is equal to 0 (TR = TC ).
c. At the production level of 70 units of vodka, the firm earns the highest profit, since this is the output at which the
difference between total revenue and total cost is maximized. As the production level decreases, the difference
between the total revenue and total cost declines, decreasing the firm’s profit.
d. Similarly to (c), the profit will decrease.
e. Firm TC
revenue
& cost ($) TR
0 20 70 120 Quantity
The line tangent to the TC curve at a quantity equal to 70 is parallel to the TR curve. This indicates that the highest
profit that the firm can obtain occurs at the production level of 70. The slope of the TR curve indicates that the mar-
ginal revenue is constant. The slope of the TC curve indicates that marginal cost is increasing over all output levels
shown here.
*6. Jiang’s Pussycats sells ceramic kittens. The marginal cost of producing a particular kitten depends on how many
kittens Jiang produces, and is given by the formula MC = 0.8Q. Thus, the first kitten Jiang produces has a marginal
cost of $0.80, the second has a marginal cost of $1.60, and so on. Assume that the ceramic kitten industry is perfectly
competitive, and Jiang can sell as many kittens as she likes at the market price of $16.
a. What is Jiang’s marginal revenue from selling another kitten? (Express your answer as an equation.)
b. Determine how many kittens Jiang should produce if she wants to maximize profit. How much profit will she make
at this output level? (Assume fixed costs are zero. It may help to draw a graph of Jiang’s marginal revenue and mar-
ginal cost.)
c. Suppose Jiang is producing the quantity you found in (b). If she decides to produce one extra kitten, what will her
profit be?
d. How does your answer to part (c) help explain why “bigger is not always better”?
6. a. Firms in perfectly competitive markets are price takers. Therefore, the marginal revenue is constant at
MR = $16
b. To maximize profit, the marginal revenue must equal marginal cost; that is,
16 = 0.8Q, which implies that
Q = 20
Thus, Jiang should produce 20 kittens to maximize her profit. The total revenue is $16 × 20 = $320 and the total
cost is the sum of marginal costs, that is, the first kitten Jiang produces has a marginal cost of $0.80, the second
has a marginal cost of $1.60, and so on: $0.80 + $1.60 + … + $15.20 + $16 = $168. The profit is $320 –
$168 = $152.
c. In this case, the marginal revenue of the additional unit is less than its marginal cost. Profit will decrease. Jiang’s
total revenue is then
21 × $16 = $336
while the total cost is
$0.80 + $1.60 + … + $16 + $16.80 = $184.80.
The profit is
$336 – $184.80 = $151.20.
d. In part (b), the profit is $152. In part (c), the profit is $151.20. An extra kitten subtracts more dollars than it adds,
because the kitten costs more to produce than the revenue it generates.
7. Heloise and Abelard produce letters in a perfectly competitive industry. Heloise is much better at it than Abelard: On
average, she can produce letters for half the cost of Abelard’s. True or False: If Heloise and Abelard are both maxi-
mizing profit, the last letter that Heloise produces will cost half as much as the last letter written by Abelard. Explain
your answer.
7. The statement is false. Each maximizes profit by producing until M R = P = MC. Since the price is the same for both,
the MC of the last unit produced will also be the same for both. Each of the two producers faces different marginal
cost curves, but both produce until the marginal cost is equal to the market price, and then stop.
*8. Hack’s Berries faces a short-run total cost of production given by TC = Q 3 – 12Q 2 + 100Q + 1000, where Q is the
number of crates of berries produced per day. Hack’s marginal cost of producing berries is 3Q 2 – 24Q + 100.
a. What is the level of Hack’s fixed cost?
b. What is Hack’s short-run average variable cost of producing berries?
c. If berries sell for $60 per crate, how many berries should Hack produce? How do you know? (Hint: You may want
to remember the relationship between MC and AVC when AVC is at its minimum.)
d. If the price of berries is $73 per crate, how many berries should Hack produce? Explain.
*9. Janis is one producer in the perfectly competitive pearl industry. Price
Janis’s cost curves are shown on the right. Pearls sell for $100, and & cost MC ATC
in maximizing profits, Janis produces 1,000 pearls per month. ($/unit) A
B C D
a. Find the area on the graph that illustrates the total revenue $100
from selling 1,000 units at $100 each. K AVC
J
b. Find the area on the graph that indicates the variable cost of E
M L
producing those 1,000 units.
I F
c. Find the area on the graph that indicates the fixed cost of
producing those 1,000 units. H G
d. Add together the two areas you found in (b) and (c) to show 0 1,000 Quantity
the total cost of producing those 1,000 units.
e. Subtract the total cost of producing those 1,000 units from the total revenue from selling those units to determine
the firm’s profit. Show the profit as an area on the graph.
9. a. The rectangle ADGH represents the total revenue when sell- Price
ing 1,000 units at $100 each. & cost MC ATC
($/unit) A
b. The variable cost at 1,000 units is represented by the area B C D
MLGH. $100
AVC
c. The fixed cost of producing 1,000 units is equal to the area K J
E
KJLM.
M
d. The total cost of producing 1,000 units is shown by the area I F L
KJGH.
e. The profit from producing 1,000 units is represented by the H G
area ADJK. 0 1,000 Quantity
10. The diagram below depicts the cost curves for a perfectly competitive jump drive producer that is currently operating
at a loss.
Price & cost
($/unit) ATC
$20 MC
18
16 AVC
14
12
10
8
6
4
2
Quantity
a. Suppose the market price of jump drives is $7. In the graph, outline an area that represents this firm’s losses if it
produces where MR = MC.
b. If the firm in (a) instead shuts down and produces zero units, it will lose only its fixed costs. Outline an area that
represents this firm’s fixed costs.
c. Which area is larger—its losses from producing where MR = MC, or its losses from producing zero units of out-
put? What should the firm do?
d. Do your answers to (a), (b), and (c) change if the price of jump drives is $11 rather than $7?
8
7 MR = 7
4
Quantity
b. The firm’s fixed costs are (ATC – AVC) × Q.
Price
$20
ATC
16 MC
14 AVC
12
8
7
4
Quantity
c. The loss from operating at MR = MC is greater. The firm should shut down immediately.
d. At a price of $11, the firm’s loss from operating would be less than its fixed costs. The firm should continue to
operate.
Price Loss from operating
= (ATC – P) × Q
$20 ATC
MC
16
14 AVC
12
11
8
7
4
Quantity
11. Marty sells flux capacitors in a perfectly competitive market. His marginal cost is given by MC = Q. Thus, the first
capacitor Marty produces has a marginal cost of $1, the second has a marginal cost of $2, and so on.
a. Draw a diagram showing the marginal cost of each unit that Marty produces.
b. If flux capacitors sell for $2, determine the profit-maximizing quantity for Marty to produce.
c. Repeat part (b) for $3, $4, and $5.
d. The supply curve for a firm traces out the quantity that firm will produce and offer for sale at various prices. As-
suming that the firm chooses the quantity that maximizes its profits [you solved for these in (b) and (c)], draw
another diagram showing the supply curve for Marty’s flux capacitors.
e. Compare the two diagrams you have drawn. What can you say about the supply curve for a competitive firm?
$5
0 5 Quantity of
flux capacitors
b. The condition P = MC implies that if flux capacitors are sold for $2, the marginal revenue is 2; hence, the quantity
produced is 2.
c. Equivalently to part (b), for prices $3, $4, and $5, the profit-maximizing quantities are 3, 4 and 5, respectively.
d. Price & cost Supply
($/capacitor)
$5
0 5 Quantity of
flux capacitors
e. The two diagrams are the same. The supply curve for a competitive firm overlaps with the marginal cost curve for
the part of the marginal cost curve that lies above minimum average variable cost. In this particular case, that is
true for all positive levels of output.
*12. Consider the graph on the right, which depicts the cost curves of a
perfectly competitive seller of potatoes. Potatoes currently sell for
$3 per pound. Price
a. To maximize profit, how many pounds of potatoes & cost MC ATC
should this seller produce? ($/pound)
AVC
Suppose that the potato grower’s bank ratchets up the in- $3
terest rate applicable to the grower’s adjustable-rate mort-
gage loan. This increases the size of the potato grower’s
monthly mortgage payment.
b. Illustrate the change in the mortgage payment by shift-
ing the appropriate cost curves.
c. Which curves shift? Which do not? Why? 0 1,000 3,000 5,000 7,000
d. How does the change in interest rates affect the grow- Quantity
er’s decision on how many potatoes to produce? of potatoes
e. What happens to the potato grower’s profit as a result
of the increased interest rate?
f. How does the change in interest rates affect the shape and/or position of the grower’s short-run supply curve?
12. a. The seller should produce at the level of output where Price
ATC*2 ATC1*
MR equals MC, which occurs at 5,000 pounds of & cost MC
potatoes. ($/pound)
AVC
b. An increase in the mortgage payment increases the $3
fixed cost of production, shifting the average total cost
curve up.
c. Only the average total cost curve shifts. The average
variable cost curve remains unchanged since the mort-
gage payment does not alter the variable cost. Simi-
larly, the marginal cost curve is not affected by the 0 1,000 3,000 5,000 7,000
increase in the fixed cost. Quantity
d. The change in interest rates has no effect on the pro- of potatoes
ducer’s decision of how many potatoes to produce in
the short run because MC does not shift. (However, if
the increased interest rate will increase the total cost
of production above total revenue, leading to a nega-
tive economic profit, then the potato grower would
shut down in the long run.)
e. The potato grower’s profit decreases. The total revenue remains unchanged but the total cost of production
increases as a result of the increase in fixed cost.
f. The grower’s short run supply is the MC curve above AVC. Since neither the MC curve nor the AVC curve shifted,
the short run supply curve is unaffected.
13. Five hundred small almond growers operate in areas with plentiful rainfall. The marginal cost of producing almonds
in these locations is given by MC = .02Q, where Q is the number of crates produced in a growing season. Three hun-
dred almond growers operate in drier areas where costly irrigation is required. The marginal cost of growing almonds
in these locations is given by MC = .04Q.
a. Find the individual supply curve for each type of almond grower. (Hint: Remember that the supply relationship
expresses the quantity brought to market at various prices. Remember also that for a competitive firm, P = MR.)
b. “Add up” the individual supply curves to derive the market supply curve.
c. If the market demand for almonds is Q d = 105,000 – 2,500P, what will the equilibrium price of almonds be? The
equilibrium quantity?
d. How many almonds will each type of almond grower produce at that price?
e. Verify that the total production of all almond growers equals the equilibrium quantity you found in part (c).
13. a. Each almond grower will supply the quantity at which price equals marginal cost. Set price equal to marginal cost,
and solve for Q.
Rainy-area growers: P = .02Q, so Q = 50P
Dry-area growers: P = .04Q, so Q = 25P
b. Multiply each supply function by the corresponding number of growers, and then find the sum for all firms:
Q S = 500(50P) + 300(25P) = 25,000P + 7,500P = 32,500P
c. Set Q s = Q d in order to find the equilibrium price:
32,500P* = 105,000 – 2,500P*
35,000P* = 105,000
P* = 3
Use P* = 3 in either equation to find the equilibrium quantity:
32,500(3) = 105,000 – 2,500(3) = 97,500
d. Rainy-area growers will grow 25,000(3) = 75,000 crates. Dry-area growers will grow 7,500(3) = 22,500 crates.
e. The sum of 75,000 and 22,500 is 97,500, as found in part (c).
14. Consider Janis the pearl producer with cost curves as shown Price
on the right. Janis produces 1,000 pearls when the price of & cost MC ATC
pearls is $100. ($/unit) A
B C D
a. What is the area of producer surplus earned by Janis if $100
the price of pearls is $100? K AVC
J
b. Explain why areas ADI and ADLM must be equal. E
M L
I F
14. a. When the price is $100, Janis produces 1,000 units. The
producer surplus earned by Janis is the area above the H G
marginal cost curve and below the demand curve, the 0 1,000 Quantity
area ADI. For each unit the firm produces below 1,000,
the marginal cost is less than the market price (P = MR),
and the firm earns a producer surplus on that unit. As a result, total producer surplus is equal to the area below the
demand curve and above MC.
b. As indicated in part (a), area ADI is the producer surplus. However, producer surplus can also be calculated by
a firm’s total revenue minus its variable cost. The firm’s total revenue at 1,000 units is the rectangle ADGH, and
its variable cost is the rectangle MLGH. Therefore, its producer surplus is the difference of those two areas, the
rectangle ADLM.
15. For the past nine months, Iliana has been producing artisanal ice creams from her small shop in Chicago. She’s been
just breaking even (earning zero economic profit) that entire time. This morning, the state Board of Health informed
her that it is doubling the annual fee for the dairy license under which she (and other ice cream makers) operates,
retroactive to the beginning of her operations.
a. In the short run, how will this fee increase affect Iliana’s output level? Her profit?
b. In the long run, how will this fee increase affect Iliana’s output level?
c. Suppose that instead of doubling the annual fee for a license, the state Board of Health required Iliana (and
other ice cream makers) to treat every pint of ice cream to prevent the growth of bacteria. How would this
regulation affect Iliana’s production decision and profit in both the short and long run?
15. a. The increase in the fee will reduce Iliana’s profits but will not change her output level. Her output level will not
change because the fee is a fixed cost that does not affect her marginal costs.
b. In the long run, Iliana will consider exiting the industry given that she is now experiencing a loss.
c. Such a requirement would add to the variable cost and the marginal cost, which would affect both the output level
and her profit in the short run and long run. Given that she only broke even before the change, Iliana would have
no choice but to exit the industry in the long run. In the short run, her decision would again depend on whether
her revenues are sufficient to cover her variable costs, in which case she would continue producing.
16. Martha is one producer in the perfectly competitive jelly industry. Last year, Martha and all of her competitors found
themselves earning economic profits.
a. If entry and exit from the jelly industry are free, what do you expect to happen to the number of suppliers in the industry
in the long run?
b. Because of the entry/exit you described in part (a), what do you expect to happen to the industry supply of jelly?
Explain.
c. As a result of the supply change you described in part (b), what do you expect to happen to the price of jelly?
Why?
d. As a result of the price change you indicated in part (c), how will Martha adjust her output?
Price S1
($/unit)
S2
P1
P2
Q1 Q2 Quantity
of jelly
c. Given the increase in the supply, the price of jelly will decrease [as shown in the graph in part (b)].
d. In the long run, Martha will decrease her production from Q1 to Q2, making zero economic profit.
Price & cost
($/unit) LMC
LATC
P1
P2
*17. The canola oil industry is perfectly competitive. Every producer has the following long-run total cost function:
LTC = 2Q3 – 15Q2 + 40Q, where Q is measured in tons of canola oil. The corresponding marginal cost function is
given by LMC = 6Q 2 – 30Q + 40.
a. Calculate and graph the long-run average total cost of producing canola oil that each firm faces for values of Q
from 1 to 10.
b. What will the long-run equilibrium price of canola oil be?
c. How many units of canola oil will each firm produce in the long run?
d. Suppose that the market demand for canola oil is given by Q = 999 – 0.25P. At the long-run equilibrium price,
how many tons of canola oil will consumers demand?
e. Given your answer to (d), how many firms will exist when the industry is in long-run equilibrium?
67
48
40
33
27
22
18
15
13 12
0 1 2 3 4 5 6 7 8 9 10
Quantity of canola oil (tons)
b. The long-run equilibrium price of canola oil is approximately $12, which is the minimum of the LATC curve.
c. Each firm will produce the quantity of canola oil that corresponds to the minimum point on the LATC curve, that
is, 4 tons of canola oil.
d. Using the demand function, we get
QD = 999 – 0.25P = 999 – 0.25 × 12 = 996
At the long-run equilibrium price, consumers will demand approximately 996 tons of canola oil.
e. Since each representative firm supplies 4 tons of canola oil, the number of suppliers in the long-run equilibrium
will be
_
996
= 249
4
18. Suppose that the restaurant industry is perfectly competitive. All producers have identical cost curves, and the industry
is currently in long-run equilibrium, with each producer producing at its minimum long-run average total cost of $8.
a. If there is a sudden increase in demand for restaurant meals, what will happen to the price of restaurant meals? How
will individual firms respond to the change in price? Will there be entry into or exit from the industry? Explain.
b. In the market as a whole, will the change in the equilibrium quantity be greater in the short run or the long run?
Explain.
c. Will the change in output on the part of individual firms be greater in the short run or the long run? Explain and
reconcile your answer with your answer to part (b).
18. a. A sudden increase in demand for restaurant meals will shift the demand curve out. As a result, the price of restau-
rant meals increases. Firms will react to this in two ways. Existing firms will move up along their short-run supply
curves to produce higher quantities (the movement from Q1 to Q2). In the long run, new firms will enter, which
would be reflected by an increase in supply, a shift of the supply curve (reflected by the increase in quantity from
Q2 to Q3).
Price
($/meal) S1
S2
D2
D1
Q1 Q2 Q3 Quantity of
restaurant meals
b. In the short run, the demand curve shifts out and the equilibrium quantity increases from Q1 to Q2. In the long
run, firms enter the market, shifting the supply curve out. The equilibrium quantity increases from Q1 to Q3. The
long-run change in the equilibrium quantity is greater.
c. In the short run, the output of a representative firm increases as a result of the demand shift. In the long run, as
more firms enter the market, the price returns to its original level. As it does, the output of a representative firm
also returns to its initial level.
19. Suppose that the market for eggs is initially in long-run equilibrium. One day, enterprising and profit-hungry egg farmer
Atkins has the inspiration to fit his laying hens with rose-colored contact lenses. His inspiration is true genius—overnight
his egg production rises and his costs fall.
a. Will Farmer Atkins be able to leverage his inspiration into greater profit in the short run? Why?
b. Farmer Atkins’ right-hand man, Abner, accidentally leaks news of the boss’ inspiration at the local bar and grill.
The next thing Farmer Atkins knows, he’s being interviewed for the NBC evening news. What short-run adjust-
ments do you expect competing egg farmers to make as a result of this broadcast? What will happen to the profits
of egg farms?
c. In the long run, what will happen to the price of eggs? What will happen to the profits of egg producers (including those
of Farmer Atkins)?
d. In the long run, who reaps the greatest benefit from Atkins’ technological breakthrough—egg producers or egg
consumers? Explain the role that competition plays in the distribution of those benefits in the transition between
the short and long run.
19. a. The cost reduction shifts down both the long-run marginal and average total cost curves. Hence, Atkins is able to
leverage his inspiration into greater profit in the short run.
b. Competitors will follow Atkins innovative technique, thus lowering their long-run marginal and average total cost
curves, which leads to higher profits.
c. In the long run, positive economic profit will attract new farmers. Supply will increase, and the supply shift will
reduce price until firm profits return to their original level.
d. Egg consumers will experience the greatest benefit. As the innovation spreads throughout the industry, farmers
who adopt it first will earn temporary economic profit. New firms will enter the industry in response. Eventually,
competition will make Atkins’ technique the new industry standard, lowering cost through higher productiv-
ity. Once this happens, consumers will be paying lower egg prices; firms in the egg industry will return to zero
economic profit.
20. General supply and demand analysis suggests that, in the short run, a decrease in demand causes the price of a good
to fall.
a. Is the same assertion true (that decreases in demand cause prices to fall) in the long run?
b. Is it possible that a decrease in demand could actually cause prices to increase in the long run? If so, explain your
reasoning.
20. a. Any difference between short-run and long-run outcomes will be found in the effects of firms entering or exiting
the industry. A decrease in demand will initially result in a lower price. If a perfectly competitive industry begins
from a point of zero economic profit, the lower price will cause some firms to exit the industry. If the departure of
these firms raises the cost structure of remaining firms, the long-run equilibrium price might not be lower.
b. If the industry is a decreasing-cost industry, its long-run supply curve is downward-sloping. Hence, the departure
of some firms in response to a decrease in demand will raise the average cost for remaining firms. In this situation,
a higher price could result in the long run.
21. Suppose eggs are produced competitively, and that the egg industry is a constant cost industry.
a. Fill in the table with appropriate responses (increases, decreases, no change) in response to each of the following
events:
b. Which event has a permanent effect on the price of eggs, and which does not?
c. How would your answer to (b) change if the egg industry were a decreasing cost industry?
21. a.
Event Short-run effect on price Long-run effect on price
b. The decrease in the cost of corn will have a permanent effect; the effect of an increase in demand is temporary.
c.
Event Short-run effect on price Long-run effect on price
22. Assume that the ice cream industry is perfectly competitive. Each firm producing ice cream must hire an operations
manager. There are only 50 operations managers that display extraordinary talent for producing ice cream; there is a
potentially unlimited supply of operations managers with average talent. Operations managers are all paid $200,000
per year.
• The long-run total cost (in thousands of dollars) faced by firms that hire operations managers with exceptional
talent is given by LTCE = 200 + Q2, where Q is measured in thousands of 5-gallon tubs of ice cream. The
corresponding marginal cost function is given by LMC E = 2Q, and the corresponding long-run average total cost is
LATCE = 200/Q + Q.
• The long-run total cost faced by firms that hire operations managers with average talent is given by
LTCA = 200 + 2Q 2. The associated marginal cost function is given by LMC A = 4Q, and the corresponding long-
run average total cost is LATC A = 200/Q + 2Q.
a. Derive the firm supply curve for ice cream producers with extraordinary operations managers.
b. Derive the firm supply curve for ice cream producers with average operations managers.
c. The minimum LATC A (for firms with average operations managers) is $40, achieved when those firms produce
10 units of output. The minimum LATCE (for firms with exceptional operations managers) is $28.28, achieved
when those firms produce 14 units of output. Explain why, given only that information, it is not possible to deter-
mine the long-run equilibrium price of 5-gallon tubs of ice cream.
d. Referring to part (c), suppose that you know that the market demand for ice cream is given by
Q d = 8,000 – 100P. Explain why, in the long run, that demand will not be filled solely by firms with extraordinary
managers. (Hint: Derive the industry supply of extraordinary producers and then use the demand curve to deter-
mine the equilibrium price. Can that price persist in the long run?)
e. In part (d), you explained why the supply side of the market will consist of both firms with extraordinary managers
and firms with average managers. What will the long-run equilibrium price of ice cream be?
f. At the price you determined in part (e), all 50 firms with extraordinary managers will find remaining in the indus-
try worthwhile. How many firms with average managers will also remain in the industry?
g. At the price you determined in part (e), how much profit will a firm with an average manager earn?
h. At the price you determined in part (e), how much profit will a firm with an extraordinary manager earn? How
much economic rent will that talented manager generate for her firm?
22. a. The firm’s average variable cost function is equal to Q, which is minimized at Q = 0. Thus, the marginal cost
function MC = 2Q is the supply curve of the firm.
b. Similarly to part (a), the supply curve for ice cream producers with average operations managers is P = 4Q.
c. The long-run equilibrium price of 5-gallon tubs of ice cream can be calculated only if we know the demand func-
tion because we need to know whether demand conditions are strong enough to permit average firms to produce.
d. There are 50 firms with extraordinary managers with an individual supply curve P = 2Q. The LATCE is minimized
when each firm produces 14 units of output. Hence, all together, they would produce 700 units of output. If those
50 firms are the only producers, then in equilibrium consumers would be willing to pay
700 = 8,000 – 100P
P = $73
for each unit. Since the price exceeds the minimum LATCA of $40, in the long run, the demand will not be filled
solely by firms with extraordinary managers. Firms with average managers will find it profitable to supply ice
cream in this market. That entry will drive down the price in the market.
e. The long-run equilibrium price of ice cream will be the minimum LATCA, which is $40.
f. At price of $40, the quantity demanded is
Q d = 8,000 – 100 × 40 = 4,000 (thousands of 5-gallon tubs of ice cream)
Firms with extraordinary managers will supply the quantity that solves the MR = MC, that is, 40 = 2Q; thus,
Q = 20. Because there are 50 such firms, the total quantity supplied by extraordinary managers is one million
5-gallon tubs of ice cream, and the rest will be supplied by firms with managers of average talent. Each of them
will produce ten thousand 5-gallon tubs of ice cream. Hence, there will be 3,000,000/10,000 = 300 firms with
average talent managers in the industry.
g. A firm with an average manager will earn zero profit because the market price is equal to the minimum LATCA:
TR A – TC A = 10 × 40 – (200 + 2 × 10 2) = 400 – 400 = 0
h. The profit for a firm with an extraordinary manager is
TRE – TC E = 20 × $40 – (200 + 20 2) = 560 – 396 = $164
The talented manager will generate the economic rent equal to the profit of a firm with an extraordinary manager,
which is $200,000.