ME Problem Set – V

PGP 2023 - 25
(Answer Keys)

1.
(a) Equilibrium price and quantity are found by setting market supply equal to market
demand: 6500 – 100P = 1200P. Solve to find P = $5 and substitute into either equation
to find Q = 6000. To find the output for the firm set price equal to marginal cost:
2q
5 , and therefore q = 500. Profit is total revenue minus total cost or
200
 q 2   2
  Pq   722   5( 500 )   722  500   $528 . Notice that since the total output in
 200  
 200 
the market is 6000, and each firm’s output is 500, there must be 6000/500 = 12 firms
in the industry.

(b) We would expect entry because firms in the industry are making positive economic
profits. As new firms enter, market supply will increase (i.e., the market supply curve
will shift down and to the right), which will cause the market equilibrium price to fall,
all else the same. This, in turn, will reduce each firm’s optimal output and profit. When
profit falls to zero, no further entry will occur.

(c) In the long run profit falls to zero, which means price falls to the minimum value of
AC. To find the minimum average cost, set marginal cost equal to average cost and
solve for q:
2q 722 q
 
200 q 200
q 722

200 q
2
q  722(200)
q  380
AC(q  380)  3.8.
Therefore, the firm will not sell for any price less than $3.80 in the long run. The long-
run equilibrium price is therefore $3.80, and at a price of $3.80, each firm’s economic
profit equals zero because P = AC.
(d) The firm will sell for any positive price, because at any positive price, marginal cost is
above average variable cost (MC = q/100 > AVC = q/200). Profit is negative if price is
below minimum average cost, or as long as price is below $3.80. Profit is zero if price is
exactly $3.80, and profit is positive if price is greater than $3.80.
2.
(a) The equilibrium price and rate of sales are computed by equating supply to demand.
25 + 0.5Q = 75 - 1.5Q
2Q = 50
Q = 25 (hundreds per day)

The equilibrium price is

P = 75 - 1.5Q
= 75 - 1.5(25)
= $37.5

(b)
Since the firm's supply curve is its MC, we can determine the rate of sales of the firm by
inserting $37.5 for price (MC) into the MC equation to get q for the firm.
MC = $37.5 = 2.5 + 10q.
q = 3.5 (hundreds per day)

(c)
The new market equilibrium price is
25 + 0.50Q = 100 - 1.5Q
Q = 75 / 2 (hundreds per day)
P = 100 - 1.5(37.5) = $43.75 / unit

Now the typical firm would sell daily:

MC = 43.75 = 2.5 + 10q
q = 4.126 (hundred per day)

(d)
The original supply and demand represented long-run equilibrium and a breakeven situation
for the typical firm. With the new higher demand in (c), the typical firm would likely be
earning a positive economic profit because price and output are both higher. This apparent
positive profit would encourage more firms to enter the market, which would increase market
supply. So, the new equilibrium would not represent a long-run equilibrium for the firm or
the market.

3.
(a)
Market equilibrium price is found by equating S and D.
75 - 1.5Q = 25 + 0.50Q
50 = 2Q
Q = 25 (thousand yards per month)
The equilibrium selling price is
P = 75 - 1.5(25) = $37.5/yard.

(b)
Since the firm's supply is based on its MC curve, we can use MC to determine production
rate.
P = 37.5 = MC = 2.5 + 10q
35
q= = 3.5 (thousand yards / month)
10
(c)
Since each firm produces 3.5 thousand yards per month and total production is at 25 thousand
yards per month, a total of 7.14 firms would be needed.

4.
The equilibrium price is the price at which the quantity supplied equals the quantity
demanded. Therefore,
.000002Q = 11 - .00002Q
Q = 500,000
P=1
(b)
The profit maximizing short run equilibrium level of output for a tortilla factory is found
where marginal revenue equals marginal cost. For a perfectly competitive firm, marginal
revenue equals price. Therefore,
P = MC
1 = .1 + .0009Q
Q = 1,000

(c)
Given the information provided, it cannot be determined whether the firm is making a profit
or a loss, because total cost cannot be determined from marginal cost.

(d)
Since Q = 500,000 and Q = 1,000, there must be 500 firms.

5.
(a) Begin by calculating the price elasticity of demand, ED:
Q P
ED = ∙
P Q
Q
To find solve for Q in terms of P.
P
P = 500 - 2Q
P - 500 = -2Q
Q = 250 - 0.5P

Q Q P
= -0.5; ED = ∙
P P Q
300
ED = -0.5 ∙ = -1.5
100
 1 
MR = P + P  

E
 D
 1 
MR = 300 + 300  
 -1.5 
MR = 300 - 200 = 100
(b)
If MC = 0, the firm is not maximizing profit since MR should be equal to MC. The firm
should expand output.
MR = 500 - 4Q = 0
4Q = 500
Q = 125

6.
(a) Since marginal cost is equal to $1.50 and the price is $2, each hot dog vendor will want to
sell as many hot dogs as possible, which is 100 per day.

(b) Each hot dog vendor is making a profit of $0.50 per hot dog at the current $2 price:
a total profit of $50. Therefore, the price will not remain at $2, because these positive
economic profits will encourage new vendors to enter the market. As new firms start
selling hot dogs, market supply will increase and price will drop until economic profits
are driven to zero. That will happen when price falls to $1.50, where price equals
average cost. (Note that AC = MC = $1.50 for firms in this industry because fixed cost
is zero and MC is constant at $1.50)
(c) At the current price of $2, the total number of hot dogs demanded is Q = 4400 –
1200(2) = 2000, so there are 2000/100 = 20 vendors. In the long run, price will fall to
$1.50, and the number of hot dogs demanded will increase to Q = 2600. If each vendor
sells 100 hot dogs, there will be 26 vendors in the long run.
(d) If there are 20 vendors selling 100 hot dogs each then the total number sold is 2000.
If Q = 2000 then P = $2, from the demand curve.
(e) At the price of $2, each vendor is making a profit of $50 per day as noted in part (b). This
is the most a vendor would pay per day for a permit.

7.
(a) Each firm’s profit maximizing quantity is where price equals marginal cost: 8.50 =
0.5 + 0.16q. Thus q = 50. Profit is then 8.50(50) – [50 + 0.5(50) + 0.08(50)2] = $150.
The industry is not in long-run equilibrium because profit is greater than zero. In long-
run equilibrium, firms produce where price is equal to minimum average cost and there
is no incentive for entry or exit. To find the minimum average cost point, set marginal
cost equal to average cost and solve for q:
50
MC  0.5  0.16q   0.5  0.08q  AC
q
2
0.08q  50
q  25.
To find the long-run equilibrium price in the market, substitute q = 25 into either
marginal cost or average cost to get P = $4.50.
(b) The new total cost function and marginal cost function can be found by multiplying
the old functions by 0.75 (or 75%). The new functions are:
2 2
Cnew (q)  .75(50  0.5q  0.08q )  37.5  0.375q  0.06q
MCnew (q)  0.375 0.12q.
The firm will set marginal cost equal to price, which is $4.50 in the long-run
equilibrium. Solve for q to find that the firm will develop approximately 34 rolls of
film (rounding down). If q = 34 then profit is $33.39. This is the most the firm would
be willing to pay per year for the new technology.
It will pay this amount only if no other firms can adopt the new technology, because if all
firms adopt the new technology, the long-run equilibrium price will fall to the minimum
average cost of the new technology and profits will be driven to zero.

8.
The firm’s ANSC curve is given by 32/Q + 2Q. To find the shut-down price, we find the
minimum level of ANSC. This occurs at the quantity at which ANSC equals MC, or
32/Q + 2Q = 4Q. Solving for Q yields Q = 4, and substituting this into the expression for
ANSC tells us that the minimum level of ANSC is equal to 32/4 + 2(4) = $8. At prices below
$8, a firm’s supply is 0. At prices above $8, a firm produces a quantity at which
P = SMC: P = 4Q, or Q = P/4. Thus, the short-run supply curve for a firm is:
0 if P  8.

s( P )   P
 4 if P  8

Since there are 60 identical producers, each with this supply curve, the short-run market
supply curve S(P) is 60 times s(P), or:
0 if P  8.
S(P)  
15 P if P  8
To find the equilibrium price, we equate market supply to market demand and solve for P:
15P = 400 – 5P, or P = 20.

9.
The solution is shown in the figure below. The producer surplus at a price of $20 is equal to
the area of triangle A, or (1/2)(20)(200) = $2,000. When the price increases to $21, producer
surplus increases by area B ($200) plus area C ($5), or $205.
 Price ($/unit)

s(P) = 10P

$21
B C
$20
A

200 210

Quantity (units)

10.
Since an individual firm will supply where P  SMC ,
P  4Q
Q  14 P
Assuming a firm will supply for any positive price this implies s ( P)  14 P . Graphically we
have

350 s(P)
300
250
200 Price=200
Price

150 A
100
50
0
0 20 40 50 60 80 100

Producer surplus for an individual firm is given by area A in the figure above which is
1 (200)50  5000 . Since all firms are identical, overall producer surplus will be
2

100(5000)  500, 000 .