Assignment 3.1 Techinal Questions

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Chapter 7
1) For each of the following graphs, identify the firm’s profit-maximizing (or loss minimizing) output. Is each firm making a profit? If not, should the firm continue to produce in the short run?

In the first graph, the firm is losing money, but it should not shut down because P > AVC. So the loss minimizing choice is to stay in business in the short run. To shut down would lead to higher losses equal to fixed costs and these losses would be more than the current losses.

In the second graph, the firm is realizing a profit because P > ATC. Consequently, it should continue to operate as long as P > AVC.

In the third graph, the firm should shut down because P < AVC. This is its loss minimizing choice as the losses will be lower than the current losses if they produce.

3) The following graph shows the cost curves for a perfectly competitive firm. Identify the shutdown point, the breakeven point and the firm’s shortrun supply curve.

The shutdown point is the point where P = the minimum AVC. The breakeven point is the point where P = the minimum ATC. The firm’s short-run supply curve is the marginal cost curve about the shutdown point which as stated is the point where P = the minimum AVC.

5) Draw graphs showing a perfectly competitive firm, and industry in longrun equilibrium.

The above graph represents perfectly competitive firm and industry in long run equilibrium.

a) How do you know that the industry is in longrun equilibrium?

The graph shows that Price=MC=minimum of ATC which is typical for long run equilibrium. At this stage, economic profits earned by any perfectly competitive firm are zero.

b) Suppose that there is an increase in demand for this product. Show and explain the short-run adjustment process for both the firm and the industry.

As the demand increases the demand curve shifts to D2. New equilibrium occurs at a price (P2) higher than earlier one. As P2 moves higher on the...
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