Answer to Question #222862 in Microeconomics for arpan

Question

A typical profit-maximizing firm in a perfectly competitive constant-cost industry is earning a positive economic profit. a. Is the market price greater than, less than, or equal to the firm’s price? Explain. b. Draw correctly labeled side-by-side graphs for both the market and a typical firm and show each of the following.   i.   Market price and quantity, labeled Pm and Qm and the firm’s quantity, labeled Q_f. ii.  The firm’s average revenue curve, labeled AR and the firm’s average total cost curve, labeled ATC. iii.  The area representing total cost, shaded completely. If one firm in the market were to raise its price, what will happen to its total revenue? Explain.                            

Answer 1

1)In the long run, the industry is in equilibrium when p=AVC has no entry and exit. When AVC<P, new entrants will enter the industry with the expectation of extracting more profit. If P<AVC, there is no economic profit, so that that firm will exit from the industry.

2) In this diagram shows both firm and industry's equilibrium. Under perfect competition, the industry is in equilibrium when all are in equilibrium. I.e., the industry was in equilibrium when quantity demanded is equal to quantity supplied. The industry's demand curve is obtained by adding the individual demand curve, and the industry's supply curve is the horizontal summation of the MC of the producer. A perfectly competitive firm earns a profit when P>ATC. The industry is in equilibrium at point e with quantity Qm and price Pm. Profit is the shaded rectangle ABCD.                               

3) If one firm in the perfectly competitive market increases its price, new entrants will enter the industry, leading to a reduction in total revenue.