ps9ans - UNIVERSITY OF WISCONSIN Economics 101 Fall 2005...

This preview shows pages 1–3. Sign up to view the full content.

UNIVERSITY OF WISCONSIN Economics 101 – Fall 2005 Wei Zhang Problem Set 9 – ANSWER KEY Perfect Competition (Chapter 14): Short Run and Long Run 1) Begin by looking at the long run equilibrium (LRE). Notice that it must be true in LRE that profit = 0. This means that P = ATC (since one way of writing profit is π = TR – TC = (P-ATC)*q). But since firms always maximize profits by producing where MR = MC , and since MR = P* in perfect competition , it must be true in LRE, that MR = P* = MC = ATC. Thus, you can always find the long run equilibrium price by looking at the intersection of MC and ATC . Below, this gives us q* and P* from the firm’s picture. This equilibrium price must be the industry price as well – which means D and S intersect at P* and Q* in the industry picture. Notice that you can figure out the number of firms in long run equilibrium by dividing Q*, the total quantity supply in the industry, by q*, the quantity produced be each firm. That is, the number of firms, n = (Q*/q*). You may be wondering how we can guarantee that in the LRE, supply and demand will intersect right at the P* that insures P = MC = ATC. The answer: the supply curve will adjust to make this true, via firm entry and exit. To see this better, let’s work through an example. Page 1 of 6 q \$ MC ATC P* Firm Q P P* Industry Demand MR = P* = Firm’s demand Market Supply Q* q*

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Example: Suppose firms are making profit in the short run. If firms are making profit in the short run, this must mean that P* > ATC. Again, since firms maximize profit by setting MR = MC, and since MR = P* in perfect competition, we see that P* = MR = MC > ATC. Graphically, we can use this profit maximization condition (MR = P* = MC) to see that each firm will produce q* in the short run. Note that profit can be seen as the shaded area below, where π = TR – TC = (P-ATC)*q. In the short run, that’s the end of the story; every firm produces q* (above), there are n = Q*/q* firms in the market, profits are positive, and everyone is happy. BUT – since there are positive profits to be had, other folks want to enter the
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 07/28/2010 for the course ECON 101 taught by Professor Hansen during the Fall '07 term at Wisconsin.

Page1 / 6

ps9ans - UNIVERSITY OF WISCONSIN Economics 101 Fall 2005...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online