Answers to End-of-Chapter Questions in Chapter 6

1. A perfectly competitive firm faces a price of £14 per unit. It has the following short-run cost schedule:

Output |0 |1 |2 |3 |4 |5 |6 |7 |8 | |TC (£) |10 |18 |24 |30 |38 |50 |66 |91 |120 | | (a) Copy the table and put in additional rows for average cost and marginal cost at each level of output. (Enter the figures for marginal cost in the space between each column.) (b) Plot AC, MC and MR on a diagram. (c) Mark the profit-maximising output. (d) How much (supernormal) profit is made at this output? e) What would happen to the price in the long run if this firm were typical of others in the industry? Why would we need to know information about long-run …show more content…

The long-run equilibrium is shown where the AR curve is tangential to the LRAC curve (and where, therefore, there is no supernormal profit). If the demand curve now shifts from D1 to D2, the equilibrium price will fall to P2. Less than normal profit will now be made. Firms will therefore leave the industry. As they do, so the industry supply curve will shift to the left, causing the price to rise again. Once the supply curve has reached S2 and price has risen back to P1, long-run equilibrium will have been restored, with the remaining firms making normal profit again.

6. Why is the profit-maximising price under monopoly greater than marginal cost? In what way can this be seen as inefficient? Because profit is maximised where MR = MC. Under monopoly, AR is downward sloping and MR is therefore less than AR (price). Thus price is greater than MC. This is seen as inefficient, since, other things being equal, if more units were produced, the value of them to consumers (i.e. the price people are prepared to pay) would exceed the marginal cost of producing them: therefore ‘society’ is losing out by increased production not taking place. These arguments are explored in section 11.1.

7. On three diagrams like Figure 6.8, illustrate the effect on price, quantity and profit of each of the following: (i) a rise in demand; (ii) a rise in fixed costs; (iii) a rise in variable costs. In each case show only the AR, MR, AC, and MC curves.