ECON111 Tutorial 10 Week 12

Question 1.a Explain why the demand curve in a perfectly competitive market is downward sloping, while the demand curve of an individual firm in a perfectly competitive market is perfectly elastic?

1. The intersection of the market supply and the market demand curve… 3. The typical firm can sell all it wants at the market price… Ounces of Gold per Day Price per Ounce Market Ounces of Gold per Day Price per Ounce Firm S $400 $400 Demand Curve Facing the Firm D 2. determine the equilibrium market price 4. so it faces a horizontal demand curve

Question 1.b Total revenue is a straight line up to the right. Its slope is constant – it is a straight line – because marginal revenue is constant. Marginal revenue is constant under perfect competition because additional units can be sold at a constant price P = $125 Q TR = P x Q MR   1 125 2 250 3 375 4 500 5 625 6 750 7 875 8 1000 9 1125 10 1250 TR Q

Profit Determination Using Total Cost and Revenue Curves Question 1.c Profit Determination Using Total Cost and Revenue Curves TC TR Total cost, revenue $385 350 315 280 245 210 175 140 105 70 35 Quantity 1 2 3 4 5 6 7 8 9 Maximum profit =$81 $130 Loss Profit Profit is maximized where the vertical distance between total revenue and total cost is greatest. At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal

Question 2.a Market equilibrium Qd = Qs When P = $8.4 Individual Firm (1,000 firms) P Q demanded Q produced MC AVC ATC 3.65 500,000 200 6.40 7.80 12.80 5.20 450,000 250 7.00 11.00 6.80 400,000 300 7.65 7.10 10.43 8.40 350,000 350 7.20 10.06 10.00 300,000 400 7.50 11.60 250,000 450 12.40 8.00 10.22 13.20 200,000 500 20.70 9.00 Market equilibrium Qd = Qs When P = $8.4 Qd = 350,000 boxes Qs = 350 X 1,000 = 350,000 boxes

Market equilibrium Qd = Qs When P = $8.4 Qd = 350,000 boxes Qs = 350 X 1,000 = 350,000 boxes

Question 2.b When P = $8.4 per box AVC = $7.20 ATC = $10.06 P > AVC Firm can cover fixed costs and some variable costs P < ATC Firm incurs an economic loss Loss per unit ATC – P = $10.06 - $8.4 = $1.66 Total loss (ATC – P) × Q = $1.66 × 350 = $581

Question 2.c, d In the long run some firms exit the market because they are incurring an economic loss, as such P = ATC. When P = ATC, P = $10 Qd = 300,000 boxes While each firm produces 400 boxes So there are 300,000/400 = 750 firms in the market (industry) Market Individual Firm P Q demanded Q produced MC AVC ATC 3.65 500,000 200 6.40 7.80 12.80 5.20 450,000 250 7.00 11.00 6.80 400,000 300 7.65 7.10 10.43 8.40 350,000 350 7.20 10.06 10.00 300,000 400 7.50 11.60 250,000 450 12.40 8.00 10.22 13.20 200,000 500 20.70 9.00

Question 3 Explain and illustrate graphically how the growing world population is influencing the world market for wheat and a representative individual wheat farmer. Increase in world population increases the market demand for wheat. The price of wheat increases and, hence, existing farmers make an economic profit This attracts entry by new farmers which increases supply, lower the price, and eliminate economic profit.

A B C Initial equilibrium is at A, demand and supply are D0 and S0, where P = $4, Q = 15,000,000 As world population increases, the market demand increases, the demand shifts right to D1 At B, the price increases to P = 5, hence MR = P increases from MR0 to MR1 Each firms responds by increasing output to Q = 225,000 Now, firms are making economic profit since P > ATC Economic profit attracts entry by new firms, leading to an increase in supply, from S1 to S1 Hence, at C, the market price falls back to the initial price P = $4, MR falls back to MR0 each produces Q = 200,000 The market equilibrium quantity is Q = 25,000,000 The firms now make zero economic profit and there is no longer an incentive for new entry.