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Tute 10answers - Introductory microeconomics ECON1001...

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Introductory microeconomics ECON1001 Semester 1 2010 Tutorial 10 Week 11 Q1 Suppose a monopolistically competitive industry is in long-run equilibrium. Suppose the government wants this industry to expand and gives each firm a specific amount (a subsidy or negative tax) for each unit produced. Draw a diagram to explain this situation. What happens to the price, quantity, and number of firms in the industry when long-run equilibrium is reestablished? QUANTITY DOLLARS ATC 1 MC 1 ATC sub P 2 P 1 = ATC 1 Q 2 MR 1 D 1 Q 1 ATC 2 MC 2 Assume a typical firm in this industry is producing at Q 1 and with price P 1 = ATC 1 since the industry is in long-run equilibrium with zero economic profit. The subsidy causes the firm’s ATC and MC curves to fall from ATC 1 and MC 1 to ATC 2 and MC 2 respectively. Given this new cost structure, the firm will produce Q 2 units of output and charge price P 2 for it. At the new output level average cost is less than price and the firm earns an economic profit equal to the area of the shaded rectangle in the above diagram. The economic profit will attract new firms into the industry, causing the above firm’s demand and marginal revenue schedules to shift back until the demand schedule is tangent to ATC 2 . When long-run equilibrium is reestablished prices will be lower, output will be higher, and there will be more firms in the industry making zero economic profit as before.
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