Intermediate Microeconomics: A Modern Approach, Seventh Edition

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Econ 301 – F07 ANSWERS TO PROBLEM SET 6 - due before you leave on Wednesday Nov 21 at Jiyoun’s office Wissink 1. Critically evaluate the following statements and explain in what way or ways they are true, false, or uncertain. a. If an entrepreneur's firm is earning zero accounting profit, then it should really consider getting out of the market. [ANSWER] Yup, if accounting profit is zero, then economic profit is NEGATIVE and so the firm should seriously consider whether or not it is worth staying open in the short run and also whether or not it is worth staying in the market in the long run. Either it needs to expect price to go up, costs to go down, or both. b. If a perfectly competitive industry is an external constant cost industry, then the normal long run equilibrium price will never change. [ANSWER] Nope… The long run equilibrium can change if factor prices and/or technology change due to exogenous events OTHER THAN a change in the number of firms in the market. c. All fixed costs are avoidable in the short run if you choose to shut down. [ANSWER] Nope… some fixed costs are sunk and even if you shut down they are not recoverable or avoidable. 2. Assume that the U.S. sugar cane industry is: 1) perfectly competitive, 2) presently in long-run equilibrium, 3) an external constant-cost industry, 4) such that each farm has a set of "typically" shaped cost curves (in particular this means that short-run supply is typically shaped), 5) such that all cane farms are the same, 6) such that sugar cane demand is typically shaped. a. Graph the present long-run equilibrium situation for both a typical plant and the entire industry. [ANSWER] b. Let the demand for sugar cane decrease because of public concern about child obesity. Explain and indicate on the graphs for the previous part, what happens in the short-run and what must happen for the industry to be in long-run equilibrium once again. [ANSWER] D 0 → D 1 In the short-run, You get P 1 , Q 1 , q 1 , N 0 , π firm <0 Thus, firms exit. In the long-run, you get P 0 , Q 2 , q 0 =q 2 , N 1 , π firm =0 with N 1 <N 0 At point A, Q 0 =q 0 *N 0 At point B, Q 1 =q 1 *N 0 At point C, Q 2 =q 2 *N 1 =q 0 *N 1
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c. Suppose now that the government is persuaded by a sugar cane lobbyist to impose a price support at the ORIGINAL price level. Using your graphs in part (a), explain what will happen consequently, that is, explain what will happen in the U.S. cane industry in the short-run and in the long-run if the support is imposed.
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