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# Full information it is unlikely that customers will

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Full information: It is unlikely that customers will always check in advance to make sure price levels are equal. Low transaction costs: Most people would be willing to pay more for a restaurant located close to home so they do not need to travel. Transaction costs do exist. Free entry and exit: A new restriction has been imposed limiting supply. b 1/4 th profit Salary compensation a 0 24 Hours worked

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4 . Initially, the market price is p = 20, and the competitive firm’s minimum average variable cost was 18, while its minimum average cost was 21. Should it shut down? Why? Now this firm’s average variable cost increases by 3 at every quantity, while other firms in the market are unaffected. What happens to its average cost? Should this firm shut down? Why? Answer: In this case, revenue covers more than variable costs (R > VC). Therefore the firm should continue producing (in the short run when FC is not avoidable) even though it suffers loss. If it shuts down the loss would be equal to the fixed costs (FC) that is higher than the loss with producing (= FC - (R -VC)). If this firm's AVC increases by \$3 at every quantity then both of its AC and MC also increase by \$3 at every quantity. With this increase, new minimum AVC =21 > P = \$20 and thus revenue will not be sufficient to cover even the variable costs (VC). So in this case the firm should shut down (in the short run) and suffer a loss of FC (instead of suffering higher loss from producing). 7. The 2010 oil spill in the Gulf of Mexico caused the oil firm BP and the U.S. government to greatly increase purchases of boat services, various oil-absorbing materials, and other goods and services to minimize damage from the spill. Use side-by-side firm and market diagrams to show the effects (number of firms, price, output, profits) of such a shift in demand in one such industry in both the short run and the long run. Explain how your answer depends on whether the shift in demand is expected to be temporary or permanent. Answer: We start in equilibrium at the intersection of D1 and SLR, with price P LR and n1 firms each producing q1, which is at the minimum of their AC curve. Then demand increases to D2. In the short-run there is no entry and the price rises to P SR at the intersection of the short-run supply curve SSR and D2. If this is the new long run demand then there will be entry since price is above the minimum of average cost. This will drop prices back down to P LR but with a larger equilibrium number of firms, n2. If the demand increase is just temporary then when demand drops back to D1 we return to the starting equilibrium with n1 firms. 11. If the cost function for Acme Laundry is C ( q ) = 10 + 10 q + q 2 , so its marginal cost function is MC = 10 + 2 q , where q is tons of laundry cleaned. What q should the firm choose so as to maximize its profit if the market price is p ? How much does it produce if p = 50?
Answer: For a competitive firm MR = p, so the firm produces where p = MC, or p = 10 + 2q. We

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Full information It is unlikely that customers will always...

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