Econ1-Fall2010-PS8-sols - Econ 1 PS #8 Solutions Fall 2010...

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Econ 1 PS #8 Solutions Fall 2010 1. a. Explain the difference between Economic and Accounting profit. Economic profit is total revenue minus explicit costs minus implicit costs, whereas accounting profit is just total revenue minus explicit costs. The difference is that economic profit also accounts for implicit costs, such as the opportunity costs of the owner’s time and the opportunity costs of other resources owned by the owner. b. Explain why a firm earns an Economic profit of zero in the long-run, competitive equilibrium. If firms earn positive profits, more firms will enter which will increase supply and lower price. If firms earn negative profits, firms will leave the market which will decrease supply and raise price. The result is that firms will earn zero economic profit in the long run. c. If a firm is producing a positive quantity in a long-run, competitive equilibrium, what can we say about Normal profit? Normal profit is always equal to implicit costs. When economic profit is zero it’s equal to the accounting profit we’d expect the firm to earn. 2. Suppose the cell phone industry is perfectly competitive and in a long-run equilibrium. Assume that the demand for cell phones suddenly decreases. a. Use a graph to illustrate what will happen to the equilibrium price and quantity of cell phones in the short run. P Q S1 D1 P LR * Q1 D2 P2 Q2 S2 Q3 Demand will shift left from D1 to D2. Equilibrium price will drop from P LR * to P 2 , and equilibrium quantity will drop from Q 1 to Q 2 .
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b. In the short run, what will happen to profits for firms in this market? Since the market is initially in a long-run equilibrium (where all firms earn zero economic profit), a fall in the price of cell phones will mean that in the short run, firms in this market will earn negative profits.
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This note was uploaded on 06/15/2011 for the course ECON 1 taught by Professor Aben during the Fall '07 term at City College of San Francisco.

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Econ1-Fall2010-PS8-sols - Econ 1 PS #8 Solutions Fall 2010...

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