Question

Sparkle is one firm of many in the market for toothpaste, which is in long-run equilibrium.
a. Draw a diagram showing Sparkle's demand curve, marginal-revenue curve, average-total-cost curve, and marginal-cost curve. Label Sparkle's profit-maximizing outputand price.
b. What is Sparkle's profit? Explain.
c. On your diagram, show the consumer surplus derived from the purchase of Sparkle toothpaste. Also show the deadweight loss relative to the efficient level ofoutput.
d. If the government forced Sparkle to produce the efficient level of output, what would happen to the firm? What would happen to Sparkle's customers?

Answer 1

a. Figure 4 illustrates the market for Sparkle toothpaste in long-run equilibrium. The profit-maximizing level of output is Q_M and the price is P_M.

b.         Sparkle's profit is zero, since at quantity Q_M, price equals average total cost.

c.          The consumer surplus from the purchase of Sparkle toothpaste is area A + B. The efficient level of output occurs where the demand curve intersects the marginal-cost curve, at Q_C. So the deadweight loss is area C, the area above marginal cost and below demand, from Q_M to Q_C.

d.         If the government forced Sparkle to produce the efficient level of output, the firm would lose money because average cost would exceed price, so the firm would shut down. If that happened, Sparkle's customers would earn no consumer surplus.