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chapter8questions - LONG RUN PROFIT MAXIMIZATION 1. Suppose...

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LONG RUN PROFIT MAXIMIZATION 1. 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. b. In the short run, what will happen to profits for firms in this market? c. In the long-run, will firms enter or exit this market? d. On your graph for part a show the effect of your answer to part c on the equilibrium price and quantity of cell phones under the assumption that this is a constant cost industry. NOTE: For extra practice, do part d under the assumption that this is an increasing cost or decreasing cost industry. a. See below. Demand will shift back from D1 to D2. Equilibrium price will drop from P LR * to P2, and equilibrium quantity will drop from Q1 to Q2. b. 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. c. Firms will exit since profits are negative. d. Since this is a constant cost industry, average costs will not change as firms exit the market. Thus, the supply curve will shift from S1 to S2 and the market will return to its initial long-run equilibrium price, P LR *. In the long-run, the equilibrium quantity will decrease to Q3. P
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This note was uploaded on 08/02/2011 for the course ECON 1 taught by Professor Tang during the Spring '08 term at UCSD.

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chapter8questions - LONG RUN PROFIT MAXIMIZATION 1. Suppose...

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