1. Homework 6 Answers
Question 1: Which is not a characteristic of a perfectly competitive industry? _B__
a. Marginal revenue is equal to the market price
b. Products from different firms in the industry are complements
c. Firms can easily enter and/or exit the industry (in the long run)
d. Firms and consumers have perfect information
Question 2: If average variable cost exceeds the market price, a firm should: __C_
a. Increase production
b. Decrease production but keep producing at positive levels
c. Shut down
d. Continue producing at current level
Question 3: In the long run, economic profits in a competitive industry are equal to: _C_
a. Accounting profits
b. Total revenue
c. Zero
d. The absolute value of fixed costs

2. Question 4: Efficiency of competitive equilibrium
Why is a competitive equilibrium efficient in the short run?
MR=MC. Cost of last unit produced is exactly equal to what buyers are willing to pay for it
b. What are the benefits to society as a whole of competitive equilibrium in the long run?
Output is produced in the least cost way (P=min LAC). Producers earn only normal profit so that all benefits are captured by consumers

3. Question 5. On the following graph of a firm’s costs in the short run, label the curves and indicate the supply function using a heavier line or different color ink

4. Question 7 Suppose that bicycles are produced by a perfectly competitive, constant cost industry. Which of the following will have a larger effect on the long-run price of bicycles: 1) a government program to advertise the health benefits of bicycling or 2) a government program that increases the demand for steel, an input into the manufacture of bicycles that is produced in an increasing cost industry? Briefly explain why.
Advertisement about health benefits: Since the supply curve faced by the individual firm is elastic, the advertisement (which shifts the demand curve out) will increase quantity but leave price unchanged.

5. Program that raises price of steel: The result will be a shift in the long-run supply curve. Price of bicycles will increase and quantity will decrease.

8. Question 9 The government of Philadelphia is currently debating whether they should implement a tax on soda. The hourly supply function for soda is P = 1+ .5QS and the hourly demand function is P = QD. Suppose the government is considering a tax of $4 on each unit that the supplier sells.
Graph the supply and demand functions for soda in the space below (on the same graph

9. P Stax = 5+.5Q S=1+.5Q Pc =8.75 Tax born by consumers P*=5.75
Tax born by producers
Ps = 4.75
Qt =7.5
Q*=9.5 5 15 Q

10. Calculate and label on the graph:
No-tax equilibrium price and quantity of soda (P*, Q*)
Supply = demand => 1+.5Q=20-1.5Q =>Q*=9.5 and P*=5.75
Price consumers pay with the tax (Pc)
At Qtax=7.5, Pc = (7.5) = 8.75
Price sellers receive with the tax (Ps)
Qtax=7.5, Ps=1+.5(7.5) = 4.75
Quantity sold with the tax (Qt)
With the tax on supply, the new supply curve will be P=5+.5Q. New equilibrium will be 5+.5Q =20-1.5Q => Qtax=7.5
Indicate the size of the tax and the tax burden born by producers and consumers on the graph
Tax = 7.5*4= 30. Consumers pay 7.5*3 = 22.5 and producers pay 7.5*1 = 7.5