Intermediate Microeconomics EC202

Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

Part A

1. Each firm in a perfectly competitive market has long run average cost represented as AC(q)
= 100q- 10+100/q. Long run marginal cost is MC=200q-10. The market demand is Qd =
2150-5P. Find the long run equilibrium output per firm, q*, the long run equilibrium
price, P*, and the number of firms in the industry, n*.
A. q*=1; P*=190; n*=1200
B. q*=2; P*=240; n*=1200
C. q*=50; P*=15; n*=200
D. q*=100; P*=9991; n*=500

2. Which of the following is not true in a long-run perfectly competitive equilibrium?

A. P  MC , where P is market price and MC is the marginal cost of a firm.
B. P  AC , where P is market price and AC is the average cost of a firm.
C. Q d  nq , where q is the supply of an individual firm, n is the number of firms in
the industry, and Qd is the market demand for a product.
D. Firms may earn negative profits.

3. The market for sweet potatoes consists of 1,000 identical firms. The market demand curve
is given by Qd = 1000 – 5P. Each firm has a short-run total cost curve of STC = 100 +
100 q + 100q2, and a short-run marginal cost curve of SMC=100+200q, where q is output.
All fixed costs are sunk. In short-run market equilibrium, each individual firm will
A. earn a short-run profit.
B. earn a short-run loss.
C. earn zero economic profit.
D. produce an output of q = 4.

4. If STC  200  2q  4q 2 , SMC  2  8q , where q is output and all fixed costs are sunk, the
firm’s short-run supply curve is
A. s( P)  2  8q for P≥2 and zero otherwise.
0 P2
B. s( P)  
0.125P  0.25 P  2
C. s( P)  2  8q for P≥0 and zero otherwise.
0 P0
D. s( P)  
0.125P  0.25 P  0

Ans: B
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

5. The market for sweet potatoes consists of 1,000 identical firms. Each firm has a short-run
total cost curve of STC = 100 + 100 q + 100q2, and a short-run marginal cost curve of
SMC=100+200q, where q is output. What is the equation of the firm’s average variable
cost curve?
A. AVC  100 / q  100  100q .
B. AVC  100 100q .
C. AVC  100 200q .
D. AVC  100 / q .

Ans: B

6. Which of the following statements about marginal revenue for a perfectly competitive firm
is incorrect, where TR stands for total revenue, P stands for price, and q stands for output?
TR
A. MR 
q
B. MR  P
TR
C. MR 
q
D. Marginal revenue is the rate at which total revenue changes with respect to changes
in output.

Ans: A
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

Part B
1. Why is the marginal revenue of a perfectly competitive firm equal to the market price?

The law of one price ensures that all transactions will take place at a single market price. A
perfectly competitive firm cannot affect the market price by increasing or decreasing production.
Therefore, for each unit produced and sold, the firm will receive the market price as revenue.
Revenue will increase with each unit sold by the market price, implying the market price is equal
to marginal revenue.

2. What is the shutdown price when all fixed costs are sunk? What is the shutdown price
when all fixed costs are nonsunk?

When all fixed costs are sunk, the shut-down price is the minimum level of average variable cost.
When all fixed costs are non-sunk, the shut-down price is the minimum level of short-run average
cost.

3. How does the price elasticity of supply affect changes in the short-run equilibrium price
that results from an exogenous shift in the market demand curve?

The supply elasticity can be used to determine the extent to which the equilibrium price will change
when demand shifts exogenously. If supply is elastic, then a shift in demand will have a smaller
impact on the equilibrium price than when supply is inelastic.

4. Explain the difference between the following concepts: producer surplus, economic
profit, and economic rent.

Producer surplus and economic profit may be equal in the short run. In particular, in the short
run,
Producer Surplus = Economic Profit + Sunk Fixed Costs.

Thus, in the short run producer surplus and economic profits differ by the level of sunk fixed costs.
However, in the long run, since no fixed costs are sunk, producer surplus and economic profit will
be equal. In general, producer surplus measures the difference between total revenue and total
non-sunk costs while economic profit measures the difference between total revenue and all total
costs.
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

These two measures differ from economic rent. Economic rent is the economic surplus that is
attributable to an extraordinarily productive input whose supply is limited. Essentially, economic
rent measures the potential increase in economic profit attributable to the scarce input above and
beyond the economic profit the firm would enjoy if the firm paid suppliers of the input an amount
equal to their reservation value. However, it is possible that the input, because of its scarcity, can
extract the economic rent from the firm so that the firm still earns zero economic profit.
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

Part C
1. Dave’s Fresh Catfish is a Arorangi District farm that operates in the perfectly competitive
catfish farming industry. Dave’s short-run total cost curve is 𝑆𝑇𝐶(𝑄) = 400 + 2𝑄 +
0.5𝑄2, where 𝑄 is the number of catfish harvest per month. The corresponding short-run
marginal cost curve is 𝑆𝑀𝐶(𝑄) = 2 + 𝑄. All of the fixed costs are sunk.

A. What is the equation for the average variable cost (𝐴𝑉𝐶)?

𝑇𝑉𝐶 = 2𝑄 + 0.5𝑄2 so 𝐴𝑉𝐶 = 𝑇𝑉𝐶/𝑄 = 2 + 0.5𝑄.

B. What is the minimum level of average variable costs?

The minimum level of 𝐴𝑉𝐶 occurs at the 𝑄 where 𝑆𝑀𝐶 = 𝐴𝑉𝐶, or 2 + 𝑄 = 2 + 0.5𝑄, or 𝑄 =
0. The minimum level of AVC is thus 2.

C. What is Dave’s short-run supply curve?

Since all fixed costs are sunk, the firm will not produce if the price is below the minimum level of
𝐴𝑉𝐶., or 2. For prices above 2, the quantity supplied is found by equation price to marginal cost,
or 2 + 𝑄 = 𝑃, which implies 𝑄 = 𝑃 − 2. Thus, the firm’s short-run supply curve is

𝑠(𝑃) = 0, 𝑖𝑓 𝑃 < 2
.
𝑠(𝑃) = 𝑃 – 2 𝑖𝑓 𝑃  2

2. 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?

First, find the minimum of AVC by setting AVC  SMC .

Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

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. What is the short-run market supply curve?

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)  20s( P)
S ( P)  10 P

C. Determine the short-run equilibrium price and quantity in this industry.

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 .
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 8 Suggested Solutions

Chapter 9

3. The raspberry growing industry in the U.S. is perfectly competitive, and each producer has
a long-run marginal cost curve given by 𝑀𝐶 (𝑄) = 20 + 2𝑄 . The corresponding long-
144
run average cost function is given by 𝐴𝐶 (𝑄) = 20 + 𝑄 + . The market demand curve
𝑄
is 𝐷(𝑃) = 2488 – 2𝑃. What is the long-run equilibrium price in this industry, and at this
price, how much would an individual firm produce? How many active producers are in the
raspberry growing industry in a long-run competitive?

The long-run competitive equilibrium satisfies the following three equations:

 Profit-maximization: 𝑃 = 𝑀𝐶, or 𝑃 = 20 + 2𝑄.
 Zero profit: 𝑃 = 𝐴𝐶, or 𝑃 = 20 + 𝑄 + 144/𝑄.
 Supply equals demand: 𝐷(𝑃) = 𝑛𝑄, or 2488 – 2𝑃 = 𝑛𝑄.
Solving these equations gives us:
𝑄 = 12.
𝑃 = 44
𝑛 = 200.