Q1

1. A number of identical stores offer film developing as a service to their customers. Suppose
that each store that offers this service has a cost function
C(q) = 50+0.5q + 0.08q2,
and marginal cost
MC(q) = 0.5 + 0.16q
 If the going rate for developing a roll of film is $8.50, is the industry in long run equilibrium?

If price of developing a roll of firm = $8.50, each firm’s optimal output level,
P=MC
8.50 = 0.5 +0.16q*
 q* =50
When q=50, each firm’s TR is P x q* = $8.50 x 50 = $425
While its TC is TC = 50 + 0.5q* = 0.08q*2
= 50 + 0.5(50) + 0.08(50)2
= $275
So each firm earns a profit, ∏ = TR – TC
= 425 – 275 = 150

Since each firm receives a positive profit, this would induce the entry of new firms. The
industry is not in LR equilibrium
Q2
A number of identical firms operate in an industry and each of them has a marginal cost
MC(q) =
You also know the market supply function is Q = 1200P.
How many firms exist in this industry?

Each firm’s supply curve is also the portion of its MC curve above the minimum AVC (in the SR) or
minimum AC (in the LR).
As the MC of each firm in this qn is always increasing with output (not U-shaped), each firm’s MC
curve is exactly the same as its Supply curve.

Each firm chooses its output level by equating P with MC

P= MC =

 q = 100P (Supply function for each firm)

Each firm is willing to sell q = 100P for every possible price P. For any price P, if there are n firms in
the market, then total market supply is
nq = Q = n(100P) (Market Supply)

Since we know that market supply, Q = 1200P

therefore, 100nP = 1200P
 n =12

12 firms exist in the industry

Q3a
A number of domestic and foreign manufacturers produce replacement parts and components for
personal computer systems. Products are standardized and price competition is stiff in this industry.
Assume that market supply and demand conditions for replacement parts can be described as
P = 50 − 0.4QD (1)
P = 14 + 0.08QS (2)
where Q is output in thousands and P is price per unit.
a. Graph and calculate the equilibrium price/output solution.

Equating the inverse demand & supply functions,

50 – 0.4Q = 14 + 0.08Q
Q* = 75 (Equilibrium output)

sub Q = 75 into (1)

P* = 50 – 0.4Q*
= 50 – 0.4(75)
= 20 (Equilibrium price)
Q3(b)
b. Graphically determine the amount of market buyer surplus and producer surplus.

CS = ½ x (50-20) x 75
= 1125

PS = ½ x (20-14) x 75
= 225
Q4
Consider a city that has a number of ice cream stands operating throughout the downtown area.
Suppose that each vendor has a marginal cost of $1.50 per ice cream sold, and no fixed cost. Suppose
the maximum number of ice cream any one vendor can sell in a day is 100.
a. If the price of an ice cream is $2, how many units of ice cream does each vendor want to sell?

Here, MC is always constant at $1.50. If price of an ice cream is $2, MR = $2.

Each vendor would want to sell as much as he can since MR is always greater than MC.

Each vendor sells 100 units.

b. If the industry is perfectly competitive, will the price remain at $2 for an ice cream? If not, what
will the price be?

No, price will not remain at $2.

When price is $2, the vendor earns a profit of MR – MC = 2 - 1.50 = $0.50 for each ice cream sold.

This would induce new entrants into the market.

Supply increases until the price is driven down to the MC of $1.50.

Q4 (Contd)
c. If each vendor sells exactly 100 ice cream a day and the demand for ice cream in the
city is Q = 4400 − 1200P, how many vendors are there?

Consider the market in LR equilibrium.

Each vendor sells 100 units at a price of $1.50 each.

When P = $1.50, consumers demand a quantity

Qd = 4400 – 1200P*
= 4400 – 1200(1.50)
= 2600

For the market to clear, Qd = QS

 2600 = nq = 100n (since q = 100)
n = 26

There are 26 vendors

Q4 (contd)
d. Suppose the city decides to regulate ice cream vendors by issuing permits. If the city
issues only 20 permits, and if each vendor continues to sell 100 ice cream a day, what
price will an ice cream sell for?

If 20 permits are issued & 20 vendors sell, then

20 x 100 = 2000 ice cream are sold each day

To clear the market, Qd = QS

4400 – 1200P = 2000
1200P = 2400
 P = $2
An ice cream will sell for $2.

e. Suppose the city decided to sell the permits. What is the highest price a vendor would
pay for a permit?

Each seller that obtains the permit can earn a profit of ($2 - $1.50) x 100 = $50 per day.

Hence a vendor would be willing to pay only up to $50 per day to acquire the permit.
Q5
The market for wheat consists of 500 identical firms, each with the total and marginal cost functions
shown:
TC = 90,000 + 0.00001Q2
MC = 0.00002Q,
where Q is measured in bushels per year. The market demand curve for wheat is
Q = 90,000,000 ‑ 20,000,000P, where Q is again measured in bushels and P is the price per bushel.
a. Determine the short run equilibrium price and quantity that would exist in the market.

For each firm, MC = 0.00002Q = P

 Q = (P / 0.00002) = 50,000P (Individual firm’s supply)

Market supply is the horizontal summation of all firms’ supply

Qs = n 50,000P
= 500(50,000)P
= 25,000,000P

To find eqm P & Q, Qd = Qs

90,000,000 – 20,000,000P = 25,000,000P
 P*= $2

Q* = 25,000,000 (2) = 50,000,000

Q5 (contd)
b. Calculate the profit maximizing quantity for the individual firm. Calculate the firm's short‑run
profit (loss) at that quantity.

In eqm, each firm would produce at the level,

P = MC
2 = 0.00002q
 q* = 100,000
And will earn
∏ = TR – TC
= P x q* - [ 90,000 + 0.00001q2]
= [2 x 100,000] - [ 90,000 + 0.00001(100,000)2]
= 10,000

c . Assume that the short‑run profit or loss is representative of the current long‑run prospects in this
market. You may further assume that there are no barriers to entry or exit in the market. Describe
the expected long‑run response to the conditions described in part b.

Since firms are earning positive economic profits, new firms will have incentive to enter the market.
This causes the market supply curve to shift rightward & price to fall. Each existing firm reduces its
output, producing at the level where P= MC.

This process continues until each firm earns zero economic profit.