Question

14. (Perfect Competition) Apples are produced in a perfectly competitive industry. As- sume that there are 100 identical firms in this industry. Below are graphs for the market supply and demand as well as the cost curves of these firms 6 MC ATC AVC 2 0 0 0 100 200 300 400 500 600 0 1 23 4 5 6 Q(kg) q(kg) (a) Draw the market supply curve for apples (b) What are the market price and quantity for apples? How much does each firm produce? (c) Show the amount of profit or loss for a firm on the graplh (d) Do you expect there to be entry of new firms into this industry, the exit of firm from this industry or neither of the above? Briefly explain (e) What is the long run equilibrium price of apples and exactly how many (iden- tical) firms will be producing the good?

Answer 1

(a)Supply curve for a perfectly competitive firm is the marginal cost curve above AVC curve

.At P=2 the MC=AVC, so from P=2 the supply curve of a firm will start.

We have to draw market supply curve and we know there are 100 firms. At price level of 2 each firm supply 2 units so 100 firms will supply 200 units. At price level 3 each firm supply 3 units so 100 firms will supply 300 units. Similarly, for rest of the units we can find market supply and joining the points we get market supply curve.

(b) Market price and quantity, we get from the intersection of market supply and market demand curve.

So, market price is 3 and market quantity is 300. There are 100 firms so quantity supplied by each firm is 3.

(c) To find whether firm is making loss or profit we will have to draw individual demand and marginal revenue curve on the right-hand side graph which is given by the equilibrium price of 3. We see that at equilibrium price level 3 and quantity 3 the ATC curve is above price level. Area below MR curve is total revenue and area below ATC is total cost. At equilibrium quantity of 3 the total cost exceeds total revenue so firm is making loss.

(d) As existing firm is making loss so there will be exit of firm from the industry. This exit will continue till price equals ATC and firms are in long run making zero profit.

(e) We can see from left hand diagram that at P=4 the market demand for apples fall to Q=200. At P=4 the quantity supplied by each firm is 4. So, the number of firms producing in long run will be 50 firms (i.e. 200/4).