Skip to main content

Exercise: competitive market

You are the owner of a firm with the following ATC, AVC, and MC:


The firm is in a competitive market, and therefore is a price taker. You also know that the demand for this firm is perfectly elastic and is equal to $30.

Solve for the optimum quantity, and find the firm's economic profit (if any). Will the firm be able to maintain its profit in the long-run? Explain.


First, set MC=MR and solve for Q. We clearly see that the firm is able to maximized its profit when it produces 287.5 units. Since the MC curve is above the ATC curve at this point, the firm is earning an economic profit of about $2781.3. No, the firm will not be able to sustain this economic profit in the long-run. This profit will entice other firms to enter the market, causing a rightward shift in the supply curve, reducing the price until every firm makes a normal profit.

Let's graph that:
If a tax of $20 per units is imposed every firm in the market, the new demand for the firm is $34 (perfectly elastic), should the firm stay open in the short run? Show the effect of the tax on the market with a graph.

add 20Q to the TC formula to represent the tax. Then, the new ATC, AVC, and MC are:

To find the optimum point and the profit (if any), set MR=MC, solve for Q. Then, plug in this Q into the ATC equation, and multiply the difference in dollars times Q to find the profit/loss.


We see that the firm is earning a negative profit, but since at the optimum quantity the firm is able to pay for its VC, the firm will stay open in the short-run.

Let's graph it:

This is the effect of a per unit tax on the market:

In the long run, some firms will be forced out of the market, further reducing the supply and increasing the equilibrium price up until every firm in this market earns a normal economic profit.

Location: New York, NY, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...
Post a Comment
Read more

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more

Microeconomics: Factor Markets

Definition: Factor markets: markets for the factors of production (example: labor and capital). Markets are formed whenever consumers and producers meet to exchange goods or services. Deriving factor demand: the demand for goods or services in the product markets creates demand for the factors of production.  An increase (decrease) in demand for good X leads the suppliers to increase their production thereby increasing (decreasing) the demand for the factors of production.   Marginal revenue product: The demand for the factor of production is formed by multiplying a firm's marginal revenue by its marginal product.  Remember that by taking the derivative of the TR function with respect to Q we are able to find the MR. Marginal product on the other hand is found by taking the derivative of the production function with respect to a factor of production (L or K for example). Marginal revenue product (MRP): the change in total revenue when one more input is employed. It decrea...
Post a Comment
Read more