EC131 #7.doc

Sara Tian EC131 ? W12 Problem Set #7 1. Ch 13 #2, 3, 5, 9 2) Short-run costs Q Total Cost Fixed Cost Variable Cost Marginal Cost Price Profit 0 $500 $500 $0 $0 $200 -$500 1 600 500 100 100 200 -400 2 650 500 150 50 200 -250 3 725 500 225 75 200 -125 4 825 500 325 100 200 -25 5 950 500 450 125 200 50 6 1200 500 700 250 200 0 3) a. Q Average Cost (AC) Average Variable Cost (AVC) Average Fixed Cost (AFC) 0 (undefined?) $0 (undefined?) 1 $600 100 500 2 325 75 250 3 241.67 75 166.67 4 206.25 108.33 125 5 190 90 100 6 200 116.67 83.33 b. The relationship among the three average cost concepts is based on how they associate with the marginal cost curve. AC represents the sum of AVC and AFC, and the MC curve passes through the minimum points of both the AVC and AC curves because the only point at which the margin and the average can be equal is where the average is neither increasing or decreasing. The calculations vaguely illustrate this relationship. It shows that MC does intersect AVC at its lowest value of $75 at q=3, however MC does not intersect AC at its minimum of $190 at q=5. At q=5, MC is at $125. c. An output of 5 maximizes the firm?s profit ($50). d. The profit-maximizing output is the output at which price equals marginal cost. Any economic activity should continue until the point at which marginal benefit equals marginal cost. Marginal benefit is the marginal revenue from selling additional units of the product. Under perfect competition, marginal revenue is always equal to the equilibrium price because the firm receives Pe on every additional unit sold. The P=MC supply rule establishes the firm?s marginal cost curve as its supply curve since marginal cost curve indicates how much output the firm is willing to supply at any given market price. 5) Q Total Cost Marginal Cost Average Cost 100 $1200 $10 $12 101 $1210 $11.98 The average cost is falling between 100 and 101 units, from $12 ($1200/100) to $11.98 ($1210/101). 9) ?Competition is a great equalizer in economic affairs.? Perfect competition in products markets promotes both process and end-results equity. Equality of opportunity, a process notion of equity, is illustrated by the two-fold market test consisting of 1) absence of barriers to entry or exit and 2) equal access to all relevant market information. Both of these characteristics define a perfectly competitive market. Horizontal equity, a notion of end-results equity, is illustrated by the market test of break-even production in the long run, at which price equals long-run average cost. This shows that investors cannot maintain an advantage indefinitely; profits are eventually competed away. Overall, the equal treatment of equals implies that the equal rates of return on investment, adjusted for risk. 2. a. The equilibrium for this perfectly competitive industry would be determined by finding the intersection of the MC (marginal cost) and AC (average cost) curves on the firm?s cost vs. quantity graph. Next, by placing the firm?s cost vs. quantity graph against the market cost vs. quantity graph, trace the Pe horizontally to the point where it intersects the demand curve of the market graph. This intersection of Pe with D curve can be used to obtain the Qe, which is a point on the supply curve. b. Market Firms c. According to the way I drew the diagrams, each firm is just breaking even because the equilibrium point lies at where MC intersects AC. This would be indicative of long-run equilibrium because this output at which the long-run marginal and long-run average cost curves intersect, at the point (MES). At this point, all the economic profit has been competed away, and the price is equal to the minimum of long-run average cost. Ch 14 4) From society?s point of view, the potential evils of pure monopoly include allocation inefficiency, production (technical) inefficiency, and inequity. Allocation inefficiency is caused because the monopolist produces at the intersection of the marginal revenue and marginal cost curves, causing price to be greater than marginal cost and net value from producing and consuming the good to not be maximized. This contrived scarcity keeps output below the efficient level. Second, production (technical) inefficiency exists when the monopolist does not produce at the MES (min. of its long-run average cost curve). The potential loss in production efficiency is tempered somewhat by the cost savings of very large scale production, which requires a few very large firms each having considerable market power. Finally, the monopoly manifests inequity by violating the process equity notion of equality of opportunity because of the barriers to entry that keep out other investors from the market. Pure monopoly also violates the end-result notion of horizontal equity because monopolists can earn and maintain excess profit, exhibiting effective market or monopoly power. 4 a. makes zero economic profit b. satisfies the criterion of production or technical efficiency