Economics 310 Price Theory Chapters 5 and 6-Pop Quiz. Department of Economics College of Business and Economics California State University-Northridge Professor Kenneth Ng Wednesday, February 24, 2016

Pop Quiz Question 1. This graph shows changes in the market price and industry output of a good over time. Assume that at C and D all short and long run adjustments have been made. A.What could cause the market price and output to change in the manner depicted below? Depict such a change on your graph. (hint: more than one thing may happen). B.Label points A, B, C and D on both graphs. Provide a brief narrative of the short and long run changes among firms. C.Draw the long run industry supply curve. Is the industry an increasing cost, constant cost, or decreasing cost industry? Explain.

Answer A Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 S 1 MC ATC P1P1 A P3P3 Demand increases, the market price rises, existing firms increase output by setting output where the new price, P 3, equals MC. The existing firms are making money because P > min ATC.

Answer B Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 A MC ATC P1P1 P3P3 Because the existing firms are making money by selling at a price P 3, new firms enter the market. As firms enter the market, the short run supply curve shifts to the right. Because there are more firms, more output is produced at every price and the price falls. At point B, the long run adjustment in the the number of firms has begun but has not been completed. B C The industry is an increasing cost industry and has an upward sloping long run supply curve because in May, after all long run adjustments have occurred, the price has not fallen back to P 1.

Answer C Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 A MC ATC P1P1 P3P3 C In May, demand decreased from D2 to D3. This causes the market price to fall. The existing firms setting P=MC decrease output. Because the new price is below the min ATC of production firms will exit the industry. D 3 P2P2

Answer D Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 A MC ATC P1P1 P3P3 C D 3 Because existing firms are losing money, firms will exit the industry. As firms exit, the short run supply curve shifts to the left. At any price less is produced because there are fewer firms in the industry. Eventually, the price rises until the least efficient producer is breaking even. Since a point D, the price has not returned to P1, the industry is an increasing cost industry. D

Answer A Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 S 1 MC ATC P1P1 A P3P3 Demand increases, the market price rises, existing firms increase output by setting output where the new price, P 3, equals MC. The existing firms are making money because P > min ATC. A

Answer B Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 A MC ATC P1P1 P3P3 Because the existing firms are making money by selling at a price P 3, new firms enter the market. As firms enter the market, the short run supply curve shifts to the right. Because there are more firms, more output is produced at every price and the price falls. Firms continue to enter until potential entrants are no longer able to make a profit. This occurs when the price has returned to P 1,, therefore this a constant cost industry. C The industry is a constant cost industry and has a flat long run supply curve because in May, after all long run adjustments have occurred, the price has fallen back to P 1.

Answer C Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 A MC ATC P1P1 P3P3 In May, demand decreased from D2 to D3. This causes the market price to fall. The existing firms setting P=MC decrease output. Because the new price is below the min ATC of production firms will exit the industry. The market has only partially adjusted at B. D 3 C B

Answer D Market Firm Quantity (firm) 0 Price P1P1 Quantity (market) Price 0 D 1 D 2 P1P1 Q1Q1 A MC ATC P1P1 P3P3 C D 3 Because existing firms are losing money, firms will exit the industry. As firms exit, the short run supply curve shifts to the left. At any price less is produced because there are fewer firms in the industry. Eventually, the price rises until the least efficient producer is breaking even. Since a point D, the price has returned to P1, the industry is a constant cost industry. 1 D AVC