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# ps4f06s - Economics 101, Problem Set 4 Solutions Alan C....

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Economics 101, Problem Set 4 Solutions Alan C. Marco December 7, 2006 1. Suppose the (perfectly competitive) market for wheat is initially at a short-run and long-run equilibrium. Show (using a two-panel graph of the Frm and the market) the short-run and long-run impact on p, Q (market quantity), and q (Frm quantity) of the following events: (a) A tax increases per-unit costs by \$1 per unit. P q AC1 MC1 AC2 MC2 q1 q0 P2 P1 P0 P Q D S3 SL2 Q1 Q2 P2 P1 P0 SL1 S2 S1 Q0 Short run: In the short run, MC and AC go up by \$1 per unit to MC 2 and AC 2 . Simultaneously, short run supply goes up by \$1 per unit to S 2 and long run supply also goes up \$1 to SL 2 . P by < 1 to P 1 , Q to Q 1 , q to q 1 Firms make negative proft at P 1 ,q 1 ( P 1 < AC 1) , so there will be entry. Long run: Entry will shi±t short run supply to the le±t to S 3 , driving price up to P 2 . At P 2 , each frm will produce q 0 again, but now there will be ±ewer frms, so the market quantity will be Q 2 . (b) A technology change reduces Fxed costs. P q AC2 AC1 MC1 q1 q0 P0 P1 P q D S1 SL1 Q0 P0 P1 SL2 S2 Q1 Short run: AC to AC 2 . MC stays the same. Simultaneously, SL shi±ts down to SL 2 . P,Q,q remain the same in the short run. Firms make proft ( P 0 > AC 2) which will prompt entry. Long run: Entry: S shi±ts to the right to S 2 . P to P 1 . At P 1 , each frm will produce less ( q 1) but now there are more frms, so market quantity will be Q 1 . 1

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(c) The demand for wheat increases. P q AC MC q1 q0 P1 P0 P Q D2 Q1 Q0 P1 P0 SL S1 S2 Q2 D1 Short run: D 1 shifts right to D 2 Price increases from P 0 to P 1 Firms increase output from q 0 to q 1 leading to a higher industry output, Q 1 . New SR equilibrium: P 1 ,Q 1 ,q 1 . Long run: Pro±t, Entry: supply shifts from S 1 to S 2 Price decreases to P 0 . Each ±rm produces less, but entry causes industry quantity to increase to Q 2 . LR equilibrium: P 0 ,Q 2 ,q 0 (d) The demand for wheat decreases. P q AC MC q0 q1 P0 P1 P Q D1 Q0 Q1 P0 P1 SL S1 S2 Q2 D2 Short run: D 1 shifts left to D 2 Price decreases from P 0 to P 1 Firms decrease output from q 0 to q 1 leading to a lower industry output, Q 1 . New SR equilibrium:
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## This note was uploaded on 04/26/2010 for the course ECON 101 taught by Professor Staff during the Spring '08 term at Vassar.

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ps4f06s - Economics 101, Problem Set 4 Solutions Alan C....

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