Section+Exercise+11+solns (1)

Section+Exercise+11+solns (1) - DepartmentofEconomics 2011

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Department of Economics               Spring  2011 University of California, Berkeley         Economics 1    Head GSI: Swetha  Doraiswamy Section Exercise 11 1. The local hairdresser industry has the structure of monopolistic competition. Your  hairdresser boasts that he is making a profit and that if he continues to do so, he will be able  to retire in five years. Use a diagram to illustrate your hairdresser’s current situation. Do you  expect this to last? In a separate diagram, draw what you expect to happen in the long run.  Explain your reasoning. Your hairdresser currently makes a profit.  His demand, marginal revenue, marginal  cost, and average total cost curves are  shown in the diagram to the right. Since this hairdresser (and all other  hairdressers) makes a positive profit equal  to the blue shaded rectangle by producing  quantity Q 1  at a price of P 1 , there will be  entry into this industry.  Quantity Price D MR ATC MC Q 1 P 1 ATC 1 Profit Quantity Price D MR ATC MC Q 1 P 1 ATC 1 D’ MR’ P 2 =ATC 2 Q 2 As more hairdressers open shops in town,  demand for the typical existing hairdresser  will fall, i.e. the demand curve and marginal  revenue curve shift leftward. This will  continue to the point at which no  hairdresser makes positive profit. This  eliminates the incentive for further entry  into the industry and long-run equilibrium  Source:    Page  1  of 5 Q1: Krugman, Wells, and Olney, 
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This note was uploaded on 04/26/2011 for the course ECON 1 taught by Professor Martholney during the Fall '08 term at University of California, Berkeley.

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Section+Exercise+11+solns (1) - DepartmentofEconomics 2011

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