ps8 - ECON 1001 Tutorial 8 Q1) Smith is a corn farmer...

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ECON 1001 Tutorial 8
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Q1)Smith is a corn farmer earning economic profits and Wesson is a wheat farmer receiving a normal profit. Wesson has an incentive to become a corn farmer because A) His accounting profits are negative. B) He is not currently covering his opportunity costs. C) He could earn more than his next best alternative. D) His accounting profits are zero. E) He dislikes Smith and wants to undermine Smith’s profit. Ans: C
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Economic π = Total Revenue – Total Cost When we calculate the economic profit, the cost we use is the opportunity cost of factors of production. In particular, the OC of whatever (may it be physical or psychological efforts) the farmer contributes to the production process is included All rational farmers of course will choose the alternative that yields the highest economic profit. Thus, Wesson will be attracted to corn farming. (C)
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Q2) One difference between the long run and the short run in a perfectly competitive industry is that A) π LR > π SR at all times. B) π SR > π LR at all times. C) Firms necessarily produce Q that minimises ATC only in the LR. D) MR = P only in the LR E) π are maximised when MR = MC only in LR Ans:C
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Options A and B are wrong. A counter-example is enough to illustrate that they are both wrong, i.e., the strict inequalities do not hold in some situations. The example: If in the short run the market price is at the minimum ATC of the perfectly competitive firms, the firms will choose to produce Q where P=MC=min ATC, earning zero profit. Note that in the LR, firms will always produce at P=MC=min ATC. In this case, π LR = π SR , not strict inequality as claimed in A and B. Option D is wrong because perfect competitive firms take price as given and hence P=MR in both SR and LR.
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A graphical illustration for the previous slide P, MC, ATC Q MC ATC P SR = P LR Q SR =Q LR
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Option E is also obviously not true. In both SR and LR (at all times), the profit maximising condition is MR = MC. Option C is the right answer. In the LR in perfectly competitive market, entry and exit are free. Positive economic profits attract entry. Negative economic profits force firm to exit. Thus, in the LR, a perfect competition firm must earn zero economic profit, hence must be producing at Q that minimises ATC.
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Q3) What is the sequence of changes resulted from how a perfectly competitive industry responds to a sudden increase in popularity of the product? The mkt D shifts to the right causing the market… C) Price to ↑. ↑π attracts new firms to enter, shifting supply to the left. LR market equilibrium will be at a higher quantity but same price as before.
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Some features of a perfectly competitive industry: Identical firms: all firms face the same cost curves. Free entry and exit.
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This note was uploaded on 04/18/2011 for the course ECON 1001 taught by Professor S.c during the Spring '10 term at HKU.

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ps8 - ECON 1001 Tutorial 8 Q1) Smith is a corn farmer...

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