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14/15 ( 04/07/2014)

14.1

Suppose that there are 100 identical firms in a perfectly competitive industry. Each firm has a short-run

total cost curve of the form

1 3

C= q + 0.2q 2 + 4q + 10

300

a. Calculate the firm’s short-run supply curve with q as a function of market price (P).

(ans) Since firm chooses q such that P=SMC(q) in the short-run, we have

P = SM C(q) ≡ ∂SC(q)/∂q

1 2

= q + 0.4q + 4

100

1

= (q + 20)2

100

√

After clearing the equation, we have following individual supply function: qs = 10 P − 20. (Try to

draw individual supply curve in the Q-P plane by yourself)

**b. On the assumption that there are no interaction effects among costs of the firms in the industry,
**

calculate the short-run industry supply curve.

Pn

(ans) Let’s denote industry supply level as Qs and individual supply level as qs . Then Qs = i=1 qs where

n is the number of firms in the industry. SR industry supply function is therefore given as follows:

100

X

Qs (P ) = qs (P )

i=1

100

X √

= 10 P − 20

i=1

√

= 1, 000 P − 2, 000

**Again, try to draw SR industry supply curve by yourself. Note that industry supply curve is constructed
**

from horizontal sum of each individual firm’s supply curve.

**c. Suppose that market demand is given by Q = −200P + 8, 000. What will be the short-run equilibrium
**

price-quantity combination?

√

(ans) At equilibrium, we must have QS (P ) = QD (P ). In this problem, therefore, 1000 P − 2, 000 =

−200P + 8, 000. Since

√

1000 P − 200P − 10, 000 = 0

√

⇐⇒ P + 5 P − 50 = 0

√ 5 225

⇐⇒ ( P + )2 =

2 4

Therefore, after this squaring the terms process, we have P=25 and Q=3,000.

Page 1 of 7

130ra TA: Answers to Nicholson Ch.14/15 ( 04/07/2014)

14.2

Suppose that there are 1,000 identical firms producing diamonds and that the total cost curve for each firm

is given by

C = q 2 + wq

**where q is the firm’s output level and w is the wage rate of diamond cutters.
**

a. If w=10, what will be the firm’s (short-run) supply curve? What is the industry’s supply curve? How

many diamonds will be produced at a price of 20 each? How many more diamonds would be produced

at a price of 21?

**(ans) When w=10, C = q 2 + 10q. Since P = SM C(q) = 2q + 10, firm’s SR supply function is given as
**

qS = P/2 − 5. Try to draw SR supply curve in Q-P plane by yourself. Industry’s supply function is

P1,000 P1,000

the sum of each firm’s supply function. Therefore, QS = i=1 qS = i=1 P/2 − 5 = 500P − 5, 000.

- If P=20, then individual firm will produce q=5, while industry level of supply will be Q=1,000*5=5,000.

**- If P=21, then individual firm will produce q=5.5, while industry level of supply will be Q=1,000*5.5=5,500.
**

Therefore, 500 more diamonds are produced at industry level. Note that as price increases, individual

and industrial outputs increase, i.e. positively sloped supply curve.

**b. Suppose that the wages of diamond cutters depend on the total quantity of diamonds produced and
**

that the form of this relationship is given by

w = 0.002Q,

**where Q represents total industry output, which is 1,000 times the output of the typical firm.
**

In this situation, show that firm’s marginal cost (And short-run supply) curve depends on Q. What

is the industry supply curve? How much will be produced at a price of 20? How much more will be

produced at a price of 21? What do you conclude about the shape of the short-run supply curve?

**(ans) Since w=0.002Q, C = q 2 + 0.002Qq and M C(q, Q) = 2q + 0.002Q. Clearly, firm’s marginal cost curve
**

depends on Q. After substituting Q = 1, 000q, individual firm’s supply function becomes q = P/4 while

industry supply function is Q = 1, 000q = 250P. When P=20, QS = 5, 000. When P=21, QS = 5, 250.

We therefore conclude that in this case, SR supply curve is positively sloped, but steeper compared to

the case of (a).

14.3

A perfectly competitive market has 1,000 firms. In the very short run, each of the firms has a fixed supply

of 100 units. The market demand is given by

Q = 160, 000 − 10, 000P.

a. Calculate the equilibrium price in the very short run.

(ans) Since each firm’s supply is fixed as 100, the industry supply is also fixed as QS = 1, 000∗100 = 100, 000.

At the equilibrium, QS = QD or 100, 000 = 160, 000 − 10, 000P . Therefore P ∗ = 6.

b. Calculate the demand schedule facing any one firm in this industry.

Page 2 of 7

130ra TA: Answers to Nicholson Ch.14/15 ( 04/07/2014)

(ans) Demand function facing one firm is the one where all other firms’ supply level are taken account, i.e.

qD = QD −(QS −qs ). Therefore, qD = QD −99, 900 = 160, 000−10, 000P −99, 900 = 60, 100−10, 000P .

**c. Calculate what the equilibrium price would be if one of the sellers decided to sell nothing or if one
**

seller decided to sell 200 units.

(ans) When one of the sellers decide to sell nothing, then there’s now 999 sellers with each one producing

100 units of output. Therefore the market supply becomes QS = 999 ∗ 100 = 99, 900. The condition

QS = QD gives the equilibrium price: P ∗ = 6.01.

- When one of the sellers decide to sell 200 units, the market supply becomes QS = 999 ∗ 100 + 200 =

100, 100. The condition QS = QD gives the equilibrium price: P ∗ = 5.99.

d. At the original equilibrium point, calculate the elasticity of the industry demand curve and the elasticity

of the demand curve facing any one seller.

**(ans) The original equilibrium point is P ∗ = 6 and Q∗ = 100, 000. The elasticity of industry demand is
**

given by

∂QD P

eq,p ≡ ·

∂P QD

6

= −10, 000 ∗

100, 000

= −0.6

Demand function facing one seller is

**qD = QD − 99, 900 = 160, 000 − 10, 000P − 99, 900
**

= 60, 100 − 10, 000P

**Therefore, the elasticity of individual firm’s demand is given by
**

∂qD P

eq,p ≡ ·

∂P qD

6

= −10, 000 ∗

100

= −600.

Suppose now that, in the short run, each firm has a supply curve that shows the quantity the firm will

supply (qi ) as a function of market price. The specific form of this supply curve is given by

qi = −200 + 50P.

Using this short-run supply response, supply revised answers to (a)−(d).

a’. P=6, Q=100,000.

**b’. Demand function facing one firm is qD = QD −(QS −qS ) = 160, 000−10, 000P −(−199, 800+49, 950P ) =
**

359, 800 − 59, 950P .

c’. P=6.002 if one of them sells nothing. P=5.998 if one of them sells 200 units.

d’. e=-0.6 for industry and e=-3597 for individual firm.

Page 3 of 7

130ra TA: Answers to Nicholson Ch.14/15 ( 04/07/2014)

14.4

Suppose the demand for frisbees is given by

Q = 100 − 2P

and the supply by

Q = 20 + 6P

a. What will be the equilibrium price and quantities for frisbees?

(ans) P ∗ = 10, Q∗ = 80.

b. Suppose the government levies a tax of 4 dollars per frisbee. Now what will be the equilibrium quantity,

the price consumers will pay, and the price firms will receive? How is the burden of the tax shared by

buyers and sellers?

**(ans) Now the price consumers pay (PD ) is not same as price suppliers receive (PS ). Instead we have,
**

PD − PS = 4. Since QD = QS , we have

Q

PD = 50 −

2

10 Q

PS = − +

3 6

Solving for equations give PD = 13 while PS = 9. Out of total tax (4 dollars) per unit, consumer pays

3 dollars while supplier pays one dollar.

c. How would your answers to parts (a) and (b) change if the supply curve were instead

Q = 70 + P ?

What do you conclude by comparing these two cases?

(ans) Follow the arguments above.

14.8

Suppose that the long-run total cost function for the typical mushroom producer is given by

T C = wq 2 − 10q + 100

where q is the output of the typical firm and w represents the hourly wage rate of mushroom pickers. Suppose

also that the demand for mushrooms is given by

Q = −1, 000P + 40, 000

**where Q is total quantity demanded and P is the market price of mushrooms.
**

a. If the wage rate for mushroom pickers is 1 dollar, what will be the long-run equilibrium output for the

typical mushroom picker?

**(ans) Now, LT C = q 2 − 10q + 100. Since LR equilibrium occurs at the minimum point of LAC curve,
**

dLAC/dq = d(q − 10 + 100/q)/dq = 1 − (100/q 2 ) = 0, we have qS = 10 and P = LRC(q = 10) = 10.

Page 4 of 7

130ra TA: Answers to Nicholson Ch.14/15 ( 04/07/2014)

b. Assuming that the mushroom industry exhibits constant costs and that all firms are identical, what

will be the long-run equilibrium price of mushrooms, and how many mushroom firms will there be?

**(ans) When we have constant costs industry, input prices do not change as industry level supply (QS )
**

increases. Therefore w=1 no matter what. Substituting P=10 into demand function gives the industry

output level which is QS = QD = 30, 000. Since each firm produces qS = 10, there should be 3,000

firms in the industry.

c. Suppose the government imposed a tax of 3 dollars for each mushroom picker hired (raising total wage

costs, w, to 4 dollars). Assuming that the typical firm continues to have costs given by

T C = wq 2 − 10q + 100

how will your answers to parts (a) and (b) change with this new, higher wage rate?

**(ans) LT C(q) = 4q 2 − 10q + 100, qS = 5, P=30, QS = QD = 10, 000. There are 2,000 firms in the industry.
**

d. How would your answers to (a), (b), and (c) change if market demand were instead given by

Q = −1, 000P − 60, 000?

(ans) Follow the arguments above.

15.2

The handmade snuffbox industry is composed of 100 identical firms, each having short-run total costs given

by

ST C = 0.5q 2 + 10q + 5

and short-run marginal costs by

SM C = q + 10

**where q is the output of snuffboxes per day.
**

a. What is the short-run supply curve for each snuffbox maker? What is the short-run supply curve for

the market as a whole?

(ans) Since SMC=q+10, short-run supply function for each firm is qS = P − 10. Short-run supply function

for the market is QS = 100qS = 100P − 1, 000. (Note that the problem asks you to draw supply

curves!)

b. Suppose the demand for total snuffbox production is given by

Q = 1, 100 − 50P

What will be the equilibrium in this marketplace? What will each firm’s total short-run profits be?

(ans) The (P,Q) that satisfies the condition QS = QD is P=14, and Q=400. Since there are 100 firms, each

firm will produce qS = 4 snuffboxes. Profit for each firm is π = P qS − ST C(qS ) = 14 ∗ 4 − 0.5 ∗ 42 −

10 ∗ 4 − 5 = 3.

Page 5 of 7

130ra TA: Answers to Nicholson Ch.14/15 ( 04/07/2014)

c. Graph the market equilibrium and compute total short-run producer surplus in this case.

(ans) Total producer surplus is 400 ∗ 4/2 = 800.

d. Show that the total producer surplus you calculated in part (c) is equal to total industry profits plus

industry short-run fixed costs.

(ans)

π = 800

industry profits = 3 ∗ 100 = 300

industry short-run fixed costs = 100 ∗ 5 = 500

Note that by just looking at the total cost function 0.5q 2 + 10q + 5, you should be able to figure out

that fixed cost is 5 (since this part does not depend on q).

15.6

Suppose the government imposed a 3 dollars tax on snuffboxes in the industry described in Problem 15.2.

a. How would this change the market equilibrium?

**(ans) As a result of tax, PD − PS = 3, while QD = QS ,
**

Q

PD = 22 −

50

Q

PS = + 10

100

Therefore we have PD = 16, PS = 13 and Q=300. Since there are 100 firms, each firm produces qS = 3.

b. How would the burden of this tax be shared between snuffbox buyers and sellers?

**(ans) As a result of tax, PD increases from 14 to 16 while PS decreases from 14 to 13. From 3 dollars of tax,
**

2 dollars are burdened by consumers and the rest by sellers.

**c. Calculate the total loss of producer surplus as a result of the taxation of snuffboxes. Show that this
**

loss equals the change in total short-run profits in the snuffbox industry. Why don’t fixed costs enter

into this computation of the change in short-run producer surplus?

(ans) Before tax, producer surplus was 800. After tax, producer surplus becomes 300 ∗ 3/2 = 450. Therefore

change in producer surplus is -350.

**before tax individual profits = π(P = 14, qS = 4) = 14 ∗ 4 − 0.5 ∗ 42 − 10 ∗ 4 − 5 = 3 (1)
**

2

after tax individual profits = π(P = 13, qS = 3) = 13 ∗ 3 − 0.5 ∗ 3 − 10 ∗ 3 − 5 = −0.5 (2)

Since there are 100 firms, total profit loss is −3.5 ∗ 100 = −350 which is exactly same as total loss in

producer surplus.

**- Why no fixed costs in this computation? Since we are only concerned in change in profits, the term
**

which stays constant (as fixed costs) does not play a role. See the underlined part on equations (1)

and (2). It doesn’t matter if 5 had been 15 or 1500000000000000 or whatever.

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