Price theory and applications 8th edition landsburg solutions manual by alexandra.mitchell765

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Chapter Seven:

Competition What’s New In This Edition I’ve rewritten much of the material on long run equilibrium (roughly pages 188-195) to stress the main ideas and avoid distractions. Unlike the 7th edition, this edition introduces the long-run supply curve before the break-even price. That’s because students, at this point in the course, already understand why supply curves matter, whereas the break-even price can seem unmotivated. In the new order of things, the discussion of break-even prices emerges naturally from the discussion of long-run supply curves. As far as the construction of the supply curve, I’ve now emphasized more strongly than ever that supply curves (like demand curves) must be constructed one point at a time, by hypothesizing a price and then asking how sellers would want to respond to that price. A new dangerous curve at the bottom of page 190 clarifies exactly what is and is not held constant during this hypothetical exercise. I’ve included (on page 193) a new section on “Changes in the Break-Even Price”, with several quick numerical examples intended to cement the idea of what a break-even price is and what it isn’t. At the bottom of page 199, I’ve added a couple of introductory paragraphs to smooth the transition from constant cost to increasing/decreasing cost industries. There are several other places in the chapter where I’ve rearranged, expanded, or in some places contracted the presentation to keep the early focus on the main points and to defer distractions. And finally, with apologies to users of earlier editions, I’ve corrected some embarrasing errors in the solutions section of this Instructors Manual.

General Discussion and Teaching Suggestions 1) I believe that the best test of understanding this material is the ability to work problems in comparative statics. (For example: When the price of steel goes down, what happens to the price and quantity of Ford automobiles, in the short run and in the long run?) I believe that one of the primary goals of a chapter on competition should be to develop that ability. Therefore I have included several worked examples in the chapter, a wealth of problems at the end (see especially problems 1, 10, 11 and 12), and a special section summarizing the basic principles that the student must master (Section 7.7). 2) For many students, it can be helpful to present a taxonomy of costs, classifying them according to the time periods over which they are fixed or variable, and according to whether they are felt by one firm or the entire industry. All of this is implicit in the text, of course, but it can be useful to place an explicit chart on the blackboard, something like this: 7–1 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

A. Industry-Wide

B. Firm-Specific

1. Sunk

2. Avoidable only by exit

3. Fixed in short run Variable in long run

4. Variable

One can then fill in the boxes with examples, such as: In Box 1A a one-timeonly surprise tax on firms in the industry; in Box 1B a one-time-only fine to be paid by the firm; in Box 2A an annual license fee; in Box 2B a yearly fine for a safety violation that the firm cannot correct; in Box 3A a rise in the price of capital; in Box 3B a rise in the cost of some firm-specific capital (e.g. the construction of a highway near land used by the firm, increasing the cost of land, which is substitutable with another factor in the long run); in Box 4A a rise in labor costs; in Box 4B a firm-specific fine per unit sold (e.g. a bar generates much noise and the owners agree to reimburse the neighbors with a fee of 5 cents per drink sold). Then one can work through the short-run and long-run consequences of a change in each kind of cost. Some cases are disposed of quickly; for example those in row 1 have no effect whatsoever and those in rows 2 and 3 have no short-run effects. In addition to the effects of changes in the various kinds of costs, students must also learn the effects of demand shifts. If they really know all of this, then they really understand the theory of competition. 3) It is traditional in this subject to assert that all costs are variable in the long run. It seems to me that there are some important exceptions (e.g. an annual license fee that does not vary with the size of the firm), and the text allows for this possibility. 4) Students who understand this chapter should be able to work the numerical exercises at the end. I tell my students that if they cannot perform these exercises, then they have missed a fundamental point.

Additional Problems 1. If North Liberty, Iowa were to impose an excise tax on all corn grown in North Liberty, the consumers of corn would actually pay part of the tax. 2. True or False: In a competitive industry, some firms might be more efficient than others on average, but all firms are equally efficient at the margin. 3. True or False: In the short run, competitive firms choose output levels to minimize their short-run average costs. 4. True or False: In the short run, a firm will shut down if its total revenue fails to exceed its fixed costs. 5. True or False: A firm that shuts down must be earning negative profits, but a firm that earns negative profits might not shut down. 6. The Z.Z. Top Company earbed zero profit in 2004 and, thanks to an increase in demand, a positive profit in 2005. True or False: The average cost of producing a Z.Z. Top was lower in 2005 than in 2004. 7. True or False: If the demand for beer increases, then beer makers will not ony earn higher total profits in the short run, they will also earn higher average profits per can. 8. True or False: If a firm’s long run average and marginal cost curves are identical to its short run average and marginal cost curves, then the firm’s shutdown price is always below its break even price. 9. True or False: In the long run, a rise in the wage rates of industrial workers will cause the price of haircuts to rise. 10. True or False: In a competitive constant-cost industry, an excise tax is partly passed on to consumers in the short run but completely passed on to consumers in the long run. 11. Suppose a series of bombings destroys several of the video stores in your neighborhood. a) What happens to the price and quantity of videos sold at one of the remaining stores in the short run? b) What happens in the long run? 12. Every doctor in Coconino County uses disposable tongue depressors to examine patients, and also must keep exactly one X-ray machine in his office. The tongue depressors cost 10 cents each and the X-ray machine rents for $100 a year. The county is considering a plan to provide each doctor with unlimited free tongue depressors. An alternative plan is to provide each doctor with a free X-ray machine. a) If medicine is a competitive industry in Coconino County, compare and contrast the short-run effects of the two plans, both for the town as a whole and at each individual doctor’s office. b) If medicine is a constant-cost competitive industry in Coconino County, compare and contrast the long run effects of the two plans, both for the town as a whole and at each individual doctor’s office. c) If medicine is an increasing-cost competitive industry in Coconino County, compare and contrast the long run effects of the two plans, both for the town as a whole and at each individual doctor’s office.

13. The Wall Street Journal reports that a number of Atlantic City casinos might shut down because of enormous outstanding debts. Comment. 14. True or False: If all people are equally efficient dishwashers, then a tax on dishwashing will be paid entirely by demanders. 15. True or False: A firm that wants to maximize its short-run profits whould operate at the minimum point of its short-run average cost curve. 16. In the city of Rochester, taxi drivers form a competitive constant cost industry. Each cab driver always rents exactly one cab and also pays for gas. a) Suppose the city decides to pay half of all the drivers’ gas expenses. Copy the following chart into your blue book and fill in each box with “goes up”, “goes down”, “unchanged”, or “uncertain”: Short Run

Long Run

Price Industry-Wide Quantity Quantity per Firm Profit per Firm Number of Firms b) Repeat part a), assuming that the city decides to pay for half of all the drivers’ cab rental expenses instead of their gas expenses. 17. The table below shows the market demand curve for widgets and the marginal cost curve of a typical firm. Each firm has fixed costs of $60. Industry-Wide Demand Price Quantity $10 975 20 950 30 900 40 800 50 600

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $10 2 20 3 30 4 40 5 50

Answer the following questions and be sure to show enough work so I can see how you got your answers. a) What is the break-even price in this industry? b) In long run equilibrium, how many firms are in the industry? c) When the industry is in long run equilibrium, what point corresponds to a price of $20 on the short run industry supply curve? 18. Many supermarkets charge cereal manufacturers for the right to display their products prominently. True or False: If this practice were banned, cereal manufacturers would be better off in the long run. 19. Suppose there is an increase in the cost of fire insurance for department stores. a) In the short run, and assuming competition, could this affect prices of goods sold at department stores? Why or why not? b) In the long run, and assuming competition, could this affect prices of goods sold at department stores? Why or why not? c) Would your answers change if instead of competition there were only one department store in town? 20. By law, each private school in Rochester must have a standard-sized gymnasium that costs $1,000,000 to construct. The Rochester City Council has 7–4 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

decided to offer aid to the local private schools and is undecided about how to do it. One possibility is to subsidize teachers’ salaries; the other is to provide each school with the required gym. a) If there is only one private school in town, which plan is more beneficial to the families who send their children there? b) If private schools constitute a competitive industry, then how does subsidizing teachers’ salaries affect the price and quantity of schooling in the short run, both for an individual school and for the market as a whole? c) If private schools constitute a competitive industry, then how does providing free gymnasia affect the price and quantity of schooling in the long run, both for an individual school and for the market as a whole? 21. In the city of Rochester, taxi drivers form a competitive constant cost industry. Each cab driver always rents exactly one cab and also pays for gas. a) Suppose the city decides to pay half of all the drivers’ cab rental expenses. What happens to the number of rides offered by each individual driver in the short run? b) Suppose the city decides to pay half of all the drivers’ cab rental expenses. What happens to the number of rides offered by each individual driver in the long run? c) Suppose the city decides to pay half of all the drivers’ gas expenses. What happens to the number of rides offered by each individual driver in the short run? 22. Suppose there is a fall in the demand for shoes. In the long run, what happens to the price of shoes, the quantity produced by the entire industry, and the quantity produced by an individual shoemaker? Does your answer depend on whether the industry is constant-cost, increasing-cost or decreasing-cost? If so, how? 23. If the market for pizza is competitive, then a rise in the price of cheese and tomatos could either increase or decrease the quantity of pizzas sold at a given pizza parlor. 24. If the restaurant industry is competitive and the wholesale price of food falls, then we can be sure that in the long run existing restaurants will serve more food than before. 25. Suppose that a decision is made to provide a government subsidy of $1000 per year to every restaurant in the town of Llareggub, regardless of how many meals that restaurant serves. In the long run, what happens to the number of meals per year served at any of the restaurants currently in business? Carefully explain your answer. 26. True or False: When a firm is able to earn positive profits, its average cost of production is lower than when it earns zero profits. 27. True or False: A competitive firm earns positive profits when it faces increasing returns to scale and negative profits when it faces decreasing returns to scale. 28. True or False: If a firm earns negative profits in the short run, it will leave the industry in the long run. 29. Suppose automobiles are produced competitively. In each of the following circumstances, determine the short-run effect on price and quantity of cars, both for the auto industry as a whole and at the Ford Motor Company: 7–5 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

a) The price of steel goes down. b) A new government policy goes into effect whereby every producer of automobiles is given a gift of $100,000 per year. c) An excellent new mass transportation system is developed. 30. Sweaters provided by a competitive constant cost industry. Determine how each of the following circumstances would affect the price of sweaters and the quantity of sweaters sold by the Better Sweater Company. a) The government announces that it will pay $500 per year to any firm engaged in making sweaters. Answer both in the short run and in the long run. b) The government announces that it will pay $5 per sweater to any company engaged in making sweaters. Answer in both the short run and the long run, and be as precise as possible about the size of the price change. 31. Repeat the preceding problem, determining long run instead of short run effects. Do any of your answers depend on whether the industry is constant cost or increasing cost? 32. Suppose there is a fall in the price of factory space. How does this affect the price and quantity of baskets produced at the WorldWideWicker Company? a) Answer in the short run. b) Answer in the long run, assuming a constant-cost industry. 33. Suppose there is a new excise tax of $5 per haircut, and assume that barber shops form a competitive constant-cost industry. What happens to the price and quantity of haircuts at Beyond Salon? a) Answer in the short run. When you shift supply curves, use your knowledge of how far they must shift to get an unambiguous answer to whether quantity at Beyond Salon goes up, goes down, or remains the same. b) Answer in the long run. When you shift supply curves, use your knowledge of how far they must shift to determine whether quantity at Beyond Salon goes up, goes down, or remains the same. c) In the long run, what happens to industry-wide quantity? What happens to the number of firms in the industry? Support your answer, making use of your answer to part (b). 34. Widgets are supplied by a constant-cost industry. One day the government orders 50 gadget-makers to instantly start making widgets instead of gadgets. (This all takes place in a country where the government can do such things.) These 50 new widget-makers have exactly the same costs as the existing widget-makers. a) In the short run, what happens to the price of widgets, the industry-wide quantity, and the quantity produced at Herman’s widget farm? b) What happens in the long run? 35. Suppose that wheat is purchased only by poor people. Their demand for wheat is given by the following schedule: Price Quantity $1 per bushel 10 bushels 2 8 3 7 4 5 Now suppose that in the spirit of Christmas, a coalition of rich people decide 7–6 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

to buy wheat and resell it to poor people for half of whatever the rich people have to pay. a) List some points on the new demand curve for wheat. b) Suppose that the rich announce their plan just before Christmas, and suppose that in the short run, the supply of wheat is fixed at 7 bushels. (That is, the supply curve for wheat is vertical at 7.) How much do poor people benefit from the generosity of the rich? c) Suppose instead that the rich announce their plan a year in advance, and suppose that wheat is supplied by a competitive constant-cost industry. Is this better or worse for poor people than if the rich had made a lastminute announcement as in part a)? 36. Suppose corn is produced only in Iowa and consumed only in California. Suppose there is a general rise in the incomes of Californians. True or False: In order to predict the long-run effect on the price of apples, it is necessary to know whether apples are a normal or an inferior good for Californians. What additional assumptions might your answer depend on? 37. Apple pies are provided by a competitive constant cost industry. Granny’s Apple Pie Shop is one of the firms in this industry. In each of the following circumstances, determine which is greater: the number of pies per day that Granny sells in the short run or the number of pies per day that Granny sells in the long run. (Assume that Granny remains in the industry in the long run.) a) A new law requires all apple pie shops to purchase an annual license. b) The price of apples increases. c) The demand for apple pies increases. 38. Gregor’s Glassware is a firm in a competitive constant-cost industry. Suppose that an earthquake shuts down half of Gregor’s competitors. What happens to the price and quantity sold of Gregor’s merchandise, both in the short run and in the long run? Justify your answers. 39. A new government regulation requires each bicycle manufacturer to purchase an air purification system to reduce hazardous fumes in the workplace. What happens to the price of bicycles in the long run? a) Answer assuming that bicycles are produced by a competitive industry. b) Answer assuming that bicycles are produced by a single monopolist. Justify your answers. 40. Suppose that bicycles are produced by a competitive constant-cost industry. Suppose that bicycling declines in popularity as more people take up in-line skating. a) What happens to the profits of bicycle manufacturers in the short run? b) What happens to the number of bicycles produced per firm in the short run? c) What happens to the profits of bicycle manufacturers in the long run? d) What happens to the number of bicycles produced per firm in the long run? Justify all of your answers. 41. Suppose that ginseng tea is provided by a competitive constant-cost industry and that a new highly publicized study shows that drinking tea increases life expectancy. What happens to the amount of tea produced by a single manufacturer? 7–7 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

a) Answer in the short run. b) Answer in the long run. 42. Suppose that the gizmo industry is in long-run equilibrium when the government suddenly orders a whole lot of new firms to enter the industry. They are forced to enter even if profits are driven below zero. a) What happens in the short-run after the new firms enter? What happens to price, industry-wide quantity, and quantity supplied by individual firms? b) What happens in the long run? (You may assume a constant-cost industry if that helps you.) 43. Determine whether each of the following statements is true or false and give reasons for your answers. a) True or False: In a competitive constant cost industry, an excise tax causes price to rise in the short run, and to rise even farther in the long run. b) True or False: In a competitive constant cost industry, a fall in demand causes each firm to supply less in the short run, and even less in the long run. 44. Determine whether each of the following statements is true or false and give reasons for your answers. a) If fixed costs rise in a competitive constant cost industry, the number of firms does not change in the short run but falls in the long run. b) If demand increases in a competitive constant cost industry, the output of a single firm increases in the short run but returns to its original level in the long run. 45. In each of the following situations, determine the effect on the price and quantity of drinks served at the Airliner Tavern. Answer first in the short run, then in the long run assuming that taverns form a constant cost indusry, then in the long run assuming that taverns form an increasing cost industry, then in the long run assuming that taverns form a decreasing cost industry. (Obviously this problem can be shortened by, for example, omitting the case of decreasing costs.) a) The wholesale price of liquor goes up. b) The owners recalculate and discover that last month’s redecoration actually cost 15% more than they’d thought. c) A disgruntled customer threatens to sue after being mistakenly served lye instead of rye. In exchange for a large payoff, the customer offers not only to withhold suit, but also to keep his mouth (or what is left of it) shut about the incident. d) The same incident occurs as in part c), but the newspapers have already found out about it. e) The yearly price of liquor licenses goes up. f) The city council passes a one-time emergency tax measure, requiring every local tavern owner to immediately contribute $30 to the town treasury. g) The owners of a neighboring establishment complain about the noise from the Airliner, and they win a court order requiring the Airliner to compensate them. The court rules that the Airliner must pay the neighbors 5 cents for each drink it serves. h) A general breakdown in family life leads to a lot more people going out to taverns. 7–8 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

i) A wealthy couple decide they really want to build a house precisely on the site now occupied by the Airliner. j) There is a general rise in the price of land. 46. In each of the following situations, determine the effect on the price and quantity of car washes sold at Al’s Car Wash. Answer first in the short run, then in the long run assuming that car washes form a constant cost indusry, then in the long run assuming that car washes form an increasing cost industry, then in the long run assuming that car washes form a decreasing cost industry. (Obviously this problem can be shortened by, for example, omitting the case of decreasing costs.) a) The cost of mechanical car wash equipment goes up. b) The motel next door to Al’s wants to expand and offers to buy him out. c) One of Al’s major pieces of equipment breaks down and needs to be repaired. d) There is an epidemic of equipment failures at car washes all over town. e) The mayor declares a one-time only Car Wash Appreciation Day, on which every car wash owner in the city is given $1000 out of city funds. f) The mayor declares that Car Wash Appreciation Day will become an annual event. g) An influential member of the city council invents an automatic car-polishing machine. When the council member discovers that no car wash wants to buy the machine, legislation is pushed through requiring every car wash to own one. (The council member’s supply curve for car-polishing equipment is upward sloping.) h) There is a general rise in wage rates. i) A story on 60 Minutes reveals that Al subscribes to the deconstructionist school of literary criticism. Workers throughout the city are so revolted that they will not work for Al unless he pays them 50 cents an hour more than they can earn at any other car wash. j) A large office building is constructed, making it impossible to see Al’s Car Wash from the road. k) The city begins using salt to clear ice off the roads in winter. (Salt causes cars to rust unless it is washed off frequently.) 47. In each of the following situations, determine the effect on the price and quantity of goose liver sold at Bambi’s House of Goose Liver. Answer first in the short run, then in the long run assuming that goose liver restaurants form a constant cost indusry, then in the long run assuming that goose liver restaurants form an increasing cost industry, then in the long run assuming that goose liver restaurants form a decreasing cost industry. (Obviously this problem can be shortened by, for example, omitting the case of decreasing costs.) a) Due to ahealth scare, the city requires all goose liver purveyors to discard their inventory and replace it with fresh goose liver. b) An incompetent but enthusiastic health inspector takes office, and is expected to periodically order all goose liver purveyors to discard their inventory at random times. c) Bambi’s vindictive ex-husband is appointed health inspectorand is expected to find Bambi $5,000 per year for spurious health violations. d) Bambi’s vindictive ex-husband is appointed health inspector and is expected to fine Bambi one-tenth of her revenueseach year for spurious health violations. 7–9 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

e) A careless employee leaves the freezer door open and all of Bambi’s goose liver needs to be replaced. f) A medical journal reports that goose liver can cause cancer. g) A medical journal reports that goose liver can prevent cancer. h) Bambi’s freezer needs to be replaced. i) Bambi has a fight with the owner of Tiny’s Discount Goose Liver Emporium, which supplies all of the goose liver restaurants in town. Consequently, she must now import all of her goose liver from the next county, and must pay additional shipping fees. j) Bambi and Tiny make up, and as a sign of friendship, Tiny agrees to supply Bambi with goose liver at half price from now on. k) Bamgi and Tiny make up, and as a sign of friendship Tiny gives her 100 free pounds of goose liver (but continues to charge the usual price when Bambi orders more). l) A new law requires all restaurant owners who serve goose liver to pass a course on “The Role of Goose Liver in a Secular Society”. Th local college charges $500 tuition for the course. m) There is a fall in the wage rate for restaurant dishwashing services. n) A new landfill comes to occupy the property next to Bambi’s. The odor from the landfill is offensive to customers. o) A new movie theater opens next door to Bambi’s, and is the only movie theater in town that allows movie-goers to bring in their own goose liver instead of buying it at the concession stand. 48. Widgets are supplied by a constant-cost competitive industry. Each individual firm faces a fixed cost of $6 and marginal costs given by the following table: Quantity Marginal Cost Quantity Marginal Cost 1 $1 5 5 2 2 6 6 3 3 7 7 4 4 8 8 Industry-wide demand is given by the following table: Prie Quantity Price Quantity $1 1200 5 700 2 1000 6 500 3 900 7 300 4 800 8 200 a) What is the break-even price in this industry? (Hint: For each possible price, figure out what quantity each firm will provide and what its profit will be. Don’t forget the $6 fixed cost.) b) In long run equilibrium, how many firms are there in this industry? 49. Moose-nose pies are produced by a competitive constant-cost industry. The industry is in long-run equilibrium and there are exactly 100 firms. The following chart shows the industry-wide demand curve and the marginal cost curve of a typical firm:

Industry-Wide Demand Price Quantity $5 250 10 200 15 150 20 100 25 50

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $5 2 10 3 15 4 20 5 25

What are the firm’s fixed costs? 50. Widgets are produced by a competitive constant cost industry where each firm has fixed costs of $10. The following chart shows the industrywide demand curve and the marginal cost curve of a typical firm. Industrywide Demand Price Quantity $10 3000 $20 2500 $30 2000 $40 1500 $50 1000 $60 500

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $10 2 $20 3 $30 4 $40 5 $50 6 $60

In long run equilibrium, how many firms are in the industry? 51. The following tables show the market demand curve for widgets and the marginal cost curve at a typical firm. The industry is constant-cost and each firm has fixed costs of $60. Answer the questions below. Firm’s Marginal Cost Curve Quantity MC 1 $40 per widget 2 60 3 80 4 100 5 120 6 140

Industry-Wide Demand Price Quantity $40 per widget 1000 60 950 80 900 100 850 120 750 140 600

a) What is the break-even price in this industry? b) In long-run equilibrium, how many firms are in this industry? 52. The following charts show points on the industry-wide demand for widgets and the marginal cost curve of a typical firm. The industry is constant cost, each firm has fixed costs of $30, and the industry is in long run equilibrium. Industry-Wide Demand Price Quantity $1 1600 3 1400 5 1200 7 1000 9 800 11 600 13 400

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $1 2 3 3 5 4 7 5 9 6 11 7 13

a) What is the price of a widget? b) Suppose the city imposes a sales tax of $6 per widget. In the short run, what is the new price of a widget? What is the new profit per firm? c) Suppose the city imposes a sales tax of $6 per widget. In the long run, what is the new price of a widget? What is the new profit per firm? d) Suppose the city imposes a license fee of $12 per firm. In the short run, what is the new price of a widget? What is the profit per firm? e) Suppose the city imposes a license fee of $12 per firm. In the long run, what is the new price of a widget? What is the profit per firm? f) Suppose the city offers an excise subsidy of $3 per widget. In the short run, what is the new price of a widget? What is the new profit per firm? (You might have to approximate.) g) Suppose the city offers an excise subsidy of $3 per widget. In the long run, what is the new price of a widget? How many firms enter the industry? (You might have to approximate.) 53. The widget industry is a constant-cost industry, so that all firms are identical. Each firm has fixed costs of $9. The following chart shows the industry wide demand curve and the marginal cost curve of a typical firm: Industry-Wide Demand Price Quantity $1 800 4 700 7 600 10 500 13 400 16 300 19 200 22 100 25 60

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $1 2 4 3 7 4 10 5 13 6 16 7 19 8 22 9 25

The industry is in long-run equilibrium. Answer the following questions, making sure to show enough work so your instructor can tell how you got your answer : a) What is the price of a widget? (Your answer should be a number.) b) Suppose the government imposes a sales tax of $9 per widget. In the short run, what is the new price of a widget? What is the profit per firm¿? What is the number of firms in the industry? c) Suppose the government imposes a sales tax of $9 per widget. In the long run, what is the new price of a widget? What is the profit per firm? What is the number of firms in the industry? d) Suppose the government offers an excise subsidy of $9 per widget. In the short run, what is the new price of a widget? What is the profit per firm? What is the number of firms in the industry? e) Suppose the government offers an excise subsidy of $6 per widget. In the long run, what is the new price of a widget? What is the profit per firm? What is the number of firms in the industry? f) Suppose the government gives every firm an annual subsidy of $4 (independent of how much the firm produces). In the short run, what is the new price of widgets? What is the profit per firm? What is the number of firms in the industry? 7–12 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

g) Suppose the government gives each firm an annual subsidy of $4 (independent of how much the firm produces). In the long run, what is the new price of widgets? What is the profit per firm? What is the number of firms in the industry? i) Suppose the demand curve shifts right a distance 900. In the short run, what is the new price of widgets? What is the profit per firm? What is the number of firms in the industry? j) Suppose the demand curve shifts right a distance 900. In the long run, what is the new price of widgets? What is the profit per firm? What is the number of firms in the industry? 54. The widget industry is a constant-cost industry, so that all firms are identical. Each firm has fixed costs of $8. The following chart shows the industry wide demand curve and the marginal cost curve of a typical firm:

Industry-Wide Demand Price Quantity $3 200 5 175 8 150 12 125 20 100 30 75

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $3 2 5 3 8 4 12 5 20 6 30

The industry is in long run equilibrium. a) Suppose the demand curve shifts rightward a distance 150. In the short run what is the new price of a widget? b) Suppose the demand curve shifts rightward a distance 150. In the long run how many firms enter or exit the industry? c) Suppose the government imposes a sales tax of $15 per widget. What is the new price of widgets in the short run? d) Suppose the government imposes a sales tax of $22 per widget. How many firms leave the industry in the long run? 55. In the widget industry. Each firm has fixed costs of $3. Here are the industry demand curve and the typical firm’s marginal cost curve: 7–13 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

Price ($)

Firm's Marginal Costs

14 13 12 11 10 9 8 7 6 5 4 3 2 1

Quantity

100

150 200

250 300 350 400

$5 per widget

Quantity 450 500

INDUSTRY WIDE DEMAND

The industry is in long run equilibrium. a) What is the price of a widget? b) How many firms are in the industry? Now suppose the government institutes a new $7 excise subsidy to widget makers (That is, firms receive $7 for each widget they sell.) c) In the short run, what is the new price of a widget? d) In the long run, what is the new price of a widget? 56. Mood rings are provided by a competitive constant-cost industry currently consisting of 100 identical firms. The following graphs show an individual firm’s Total Cost for producing various quantities of output, and the market demand curve: Firm’s Total Cost Quantity Total Cost $0 300 1 400 2 450 3 510 4 590 5 700 6 840 7 1020 8 1250

Industry Demand Price $360 290 230 180 140 110 80

Quantity 400 500 600 700 800 900 1000

a) What is the current price of a mood ring? b) In the long run, how many firms will enter or exit this industry? (Don’t worry if your answer is not a while number.) 7–14 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

57. The following chart shows the industry-wide demand for widgets and the marginal cost curve of a typical firm. The industry is constant-cost and is in long run equilibrium. The price of a widget is $7. Industrywide Demand Price Quantity $10 500 $9 1000 $8 1500 $7 2000 $6 2500 $5 3000

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $1 2 $2 3 $3 4 $5 5 $7 6 $9

a) On the industry’s short-run supply curve, what quanitity is associated with a price of $9? b) What are the firm’s fixed costs? (Your answer should be a number of dollars.) 58. Moose-nose pies are produced by a competitive constant-cost industry. The industry is in long-run equilibrium and Moose-Nose pies sell for $25 each. The following chart shows the industry-wide demand curve and the marginal cost curve of a typical firm: Industry-Wide Demand Price Quantity $5 100 10 125 15 150 20 250 25 300

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $5 2 10 3 15 4 20 5 25

a) How much are the fixed costs at each firm? (Your answer should be a number.) b) Answer in the short run: If a fall in demand causes the equilibrium price of moose-nose pies to fall to $15, what is the new (industry-wide) equilibrium quantity of moose-nose pies? By how much does the industry-wide quantity fall in the short run? (Your answer should be a number.) 59. Widgets are produced by a constant cost industry, where fixed costs are $12 per firm per year. The industry is in long-run equilibrium. The following charts show the industry-wide demand curve and the marginal cost curve at a typical firm: Industry-Wide Demand Price Quantity ($/Widget) (Widgets/Year) $2 1200 4 800 6 600 8 500 10 400 12 300

Firm’s Marginal Cost Curve Quantity Marginal Cost (Widgets/Year) ($/Widget) 1 $2 2 4 3 6 4 8 5 10 6 12

a) In long run equilibrium, how many widgets does the industry produce each year? 7–15 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

b) Suppose the government wants the industry to produce 800 widgets per year in the long run and plans to accomplish this by giving every widget firm an annual cash gift. How big should the gift be? (Your answer should be a number of dollars per firm.) c) Supose the government wants the industry to produce 800 widgets per year in the long run and plans to accomplish this by giving every widget firm a subsidy for each widget they produce. How big should the subsidy be? (Your answer should be a number of dollars per widget.) d) Between the annual cash gift and the subsidy per widget, which plan is more expensive for the taxpayers? 60. Widgets are provided by a competitive constant-cost industry where each firm has fixed costs of $30. The following charts show the industry-wide demand curve and the marginal cost curve of a typical firm. Industry-Wide Demand Price Quantity $5 1500 10 1200 15 900 20 600 25 300 30 200 35 140 40 50

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $5 2 10 3 15 4 20 5 25 6 30 7 35 8 40

a) What is the price of a widget? b) How many firms are in the industry? For the remaining four parts of this problem, suppose the government imposes an excise tax of $15 per widget. c) In the short run, what is the new price of widgets? d) In the short run, how many firms leave the industry? e) In the long run, what is the new price of widgets? f) In the long run, how many firms leave the industry? 61. Widgets are provided by a constant cost industry, where fixed costs are $3 per firm per year. The industry is in long-run equilibrium. The following charts show the industry-wide demand curve and the marginal cost curve at a typical firm: Industry-Wide Demand Price Quantity ($/Widget) (Widgets/Year) $2 1200 5 800 9 600 14 500 20 400 27 300

Firm’s Marginal Cost Curve Quantity Marginal Cost (Widgets/Year) ($/Widget) 1 $2 2 5 3 9 4 14 5 20 6 27

Suppose the government wants the industry to produce 1200 widgets per year in the short run, and plans to accomplish this by offering firms a subsidy for each widget they produce. How big should the subsidy be? (Your answer should be a number of dollars per widget.) 7–16 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

62. Dogfood is provided by a competitive constant-cost industry in which each firm has the following marginal cost curve: Quantity (# of Cans per Year) 1 2 3 4 5 6 7

Marginal Cost (Price per Can) 5 10 15 20 25 30 35

The industry is in long run equilibrium and dogfood sells for $10 per can. Now a new law requires each dogfood firm to buy a license for $25 a year. In the long run, what is the new price of dogfood? 63. Widgets are provided by a constant-cost industry. The following charts show the foreign demand for American widgets and the marginal cost curve of a typical American widget firm. Foreign Demand Price Quantity $3 150 5 140 7 120 9 100 11 90 13 80 15 70 17 60

Firm’s Marginal Cost Curve Quantity Marginal Cost 1 $3 2 5 3 7 4 9 5 11 6 13 7 15 8 17

Initially, American firms are not allowed to sell to foreigners. In the U.S. , widgets sell for $7 apiece. a) What is the fixed cost of running a widget firm? Now the government decides to issue 10 export licenses; a firm with an export license can sell as many widgets to foreigners as it wants to. The export licenses are sold at auction to the highest bidders. b) What is the price of an American widget sold on the foreign market? c) What is the price of an export license? d) After the export licenses are issued, what is the new price of an American widget sold in America? Be sure to justify your answer.

Price Theory and Applications by

Steven E. Landsburg Solutions to Problem Set for Chapter 7 1. a) This is a change in a fixed cost; nothing happens. b) This is a fall in marginal cost. Gus’s MC curve falls; that is, his supply curve shifts rightward. The industry supply curve also shifts rightward, leading to a lower price for cab rides and hence a lower (flat) demand curve for Gus’s services. Price is down; quantity can go either way. c) Normally, we expect that the demand for Gus’s cab rides is flat at the going market price for cab rides. This expectation is justified by the assumption that Gus’s cab rides are no different than anyone else’s. But in this problem, we depart from that assumption. The demand for cab rides generally is unchanged; likewise for supply; thus the industry price of cab rides is unchanged. But the demand for Gus’s cab rides falls, hence the price and quantity of Gus’s cab rides falls. d) Demand for cab rides falls; price of cab rides falls; therefore the (flat) demand curve for Gus’s cab rides falls. No change in supply curves. Quantity falls at Gus’s firm, and also falls industry-wide. e) Sunk cost; no effect. f) This increases the opportunity cost of driving a cab. To completely solve the problem, you’ve got to decide whether it’s an increase in fixed costs or in marginal costs. The answer depends on what you assume about Gus’s alternative opportunities. Suppose first that Gus must choose between driving a cab and working in a factory; he can’t do both. In that case, the wages of factory workers are a fixed cost of driving a cab; you give up the same factory job whether you collect one fare a day or ten fares a day. A change in fixed cost has no effect on price or quantity. But suppose alternatively that Gus can moonlight, working in the factory for part of the day and driving the cab for the other part of the day. Then each additional cab fare requires him to lose more time in the factory, making factory wages a variable cost. In this case, the analysis is exactly as in Exhibit 7.9. g) Ordinarily, we expect exit to be impossible in the short run, but in this example, firms are forced to exit immediately. Therefore the industry supply curve shifts left, price rises, the (flat) demand curve for Gus’s cab rides rises accordingly, and his quantity rises also. h) Industry supply shifts leftward (because all the other firms’ supply curves shift leftward); price up; Gus’s quantity up. i) Change in fixed costs does not affect anything. j) Two ways to do this: Method I: Treat city-owned cabs as a separate good from private cabs. The city-owned cabs reduce demand for private cabs, so price falls, Gus’s (flat) demand curve falls, and his quantity falls. Method II: Treat city-owned cabs and private cabs as identical goods. Supply of cab rides increases, so price falls, Gus’s (flat) demand curve falls, and his quantity falls. k) Industry supply shifts rightward (because all other firm’s supply curves shift rightward); price down; Gus’s quantity down. l) Gus’s MC curve shifts up (that is, his supply curve shifts left). Very few firms are affected, so industry supply hardly moves; we can assume (to a good approxima7–19 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

tion) that it doesn’t move at all. Therefore price unchanged and Gus’s quantity down. m)Sunk cost; no effect. 2.

False; a competitive firm does not need to lower its price to “steal customers”.

False; the profit on the last item produced is zero, but that doesn’t make the firm’s total profit equal to zero.

False; in Exhibit 7.6, if the price is above P0 but below the minimum of the average cost curve, the firm earns negative profit but continues to produce in the short run.

People with no special skills must be indifferent between engraving gold jewelry and the next best opportunity. Therefore the opportunity to keep the gold dust must be exactly offset by lower wages in this industry.

False. Although typesetting is not a part of the short run marginal cost of producing books (so that a change in the cost of typesetting would have no effect on the price of books in the short run), firms do take account of typesetting costs in deciding whether to enter. Thus the cost of typesetting does enter into the determination of the industry’s long run supply curve.

True. In either case the (industry) supply curve shifts vertically by an amount equal to the excise tax. In the long run, the supply curve is vertical, so the price rises by the full amount of the tax.

False. More homeless people will move to New York, increasing crowding at shelters, making it more difficult to get handouts, and so forth, until New York is again no more attractive than the next best alternative.

9. a) At a price of $6, the quantity of car washes demanded is 200 (2 car washes per consumer times 100 consumers) and the quantity supplied is also 200 (4 per supplier times 50 suppliers). Therefore $6 is an equilibrium price. 5 b) Car washes must break even selling at $6. Variable costs are $(3 + 4 + 5 + 6) = $18 and revenue is $6 × 4 = $24, so fixed costs must be $(24 − 16) = $8. 10. a) This is a fall in variable cost. It lowers the break-even price, so the industry-wide supply curve shifts (vertically) down. Therefore the (flat) demand curve for Gus’s services shifts down. Gus’s supply (=MC) curve also shifts vertically down. From these observations, we can see that price is down, industry quantity is up, and Gus’s quantity might be either down or up. If we treat all cab rides as identical, it might be reasonable to assume that an increase in the price of gas adds a single constant to the marginal cost of each cab ride. (For example, if each ride uses two gallons of gas, and the price of gas goes up by 10 cents a gallon, the marginal cost of each cab ride goes up by 20 cents per ride.) (This assumption might be false if, for example, cabs use more gas per mile when they’re heavily used.) If we make this assumption, then both the industry supply curve and Gus’s supply curve shift vertically down by exactly the same amount. In that case, we can conclude that Gus’s quantity is unchanged. b) This is a fall in fixed cost. The break-even price drops, so the industry supply curve shifts vertically down, so the (flat) demand curve for Gus’s cab shifts vertically down. His supply curve does not shift. Price is down, industry quantity is up, Gus’s quantity is down. c) To keep customers, Gus must lower his price. But he was earning zero profit to begin with, so he won’t be willing to do this. Therefore Gus exits. 7–20 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

d) Industry-wide demand falls; no change in price; no change in supply or demand for Gus’s cab, hence no change in Gus’s quantity. (Some firms, possibly including Gus’s, will exit.) e) Sunk cost; no effect. f) As in the answer to problem 1, this can be interpreted either as an increase in fixed costs or an increase in variable costs. Under the first interpretation, see Exhibit 7.15; under the second, see Exhibit 7.16. g) No change in the cost of operating a cab service, so no change in anything. (In the short run, the remaining firms earn positive profits; these profits draw entry till the original equilibrium is restored. Entry must continue until price reaches its original equilibrium, because until that happens, firms are still earning positive profits.) h) Break-even price rises by $1 so price of cab rides rises by $1 and Gus supplies more rides. i Break-even price up; price up; Gus supplies more rides. j If you think of the city taxis as a separate industry that competes with private taxis, this can be analyzed just as in 10d). If you think of the city taxis as part of the private cab industry, then no curves move (no supply curves move because no costs have changed). The first method tells you that if the city operates 100 cabs, demand shifts left by 100 and the total number of private cabs falls by 100. The second method tells you that the total number of cabs (city plus private) remains unchanged. Notice that these are two ways of saying the same thing (as they must be because both methods are correct). Either way, price is unchanged and Gus’s supply curve is unchanged, so nothing changes at Gus’s cab company (unles he is one of the 100 who exit). k Break-even price falls so price of cab rides falls; Gus, who was earning zero profit to beging with, exits. l Gus’s marginal cost curve rises; his profits become negative and he exits. m It might or might not be worth Gus’s while to make this one-time payment; the alternative is to leave the industry, which presumably is a costly procedure (advertising for someone to buy his cab, etc.) He’ll do whichever is cheaper. 11. a) Break-even prices fall so industry supply moves vertically down (i.e. leftward). Price falls, flat demand curve for Gus’s services falls, Gus’s quantity falls. b) Variable cost falls, so Gus’s MC curve falls. Break-even prices fall so industry supply moves vertically downward (i.e. leftward). Price down, flat demand curve for Gus’s services down. Price falls by more than the drop in MC; Gus’s supply curve falls vertically by exactly the drop in MC; therefore Gus supplies fewer rides. c) To keep customers, Gus must lower his price. He might either do this or leave the industry. If he lowers his price, he provides fewer rides. d) Industry-wide demand falls; price rises; quantity up. e) Sunk cost; no effect. f) As in the answer to problem 4, this can be interpreted either as an increase in fixed costs or an increase in variable costs. Under either interpretation, industry supply moves vertically upward and price rises, so flat demand curve for Gus’s services rises. On first interpretation he moves along his supply curve and supplies more rides; on second interpretation his supply curve moves also. g) No change in the cost of operating a cab service, so no change in anything. h) Break-even price rises so price of cab rides rises and Gus supplies more rides. i Industry supply moves vertically up; price up; Gus supplies more rides. j Can be analyzed just as in 11c). 7–21 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

k Industry supply moves vertically down so price of cab rides falls; Gus, either supplies fewer rides or exits. l Gus’s marginal cost curve rises; he either supplies fewer rides or exits. m Gus either makes the payment, which becomes a sunk cost and has no further effect, or leaves the industry. 12. a) Break-even prices falls so industry supply falls. Price falls, flat demand curve for Gus’s services falls, Gus’s quantity falls. b) Variable cost falls, so Gus’s MC curve falls. Break-even price falls so industry supply falls. Price down, flat demand curve for Gus’s services down. A good answer: Demand for Gus’s services is down, his supply curve has shifted rightward, so quantity could move either way. A more in-depth answer: Assume the cost of gas per cab ride has fallen by, say, 50 cents. Then the break-even price has also fallen by 50 cents. Demand and supply fall by exactly the same distance, so quantity is unchanged. c) To keep customers, Gus must lower his price. He might either do this or leave the industry. If he lowers his price, he provides fewer rides. d) Industry-wide demand falls; price falls; quantity down. (Some firms, possibly including Gus’s, will exit.) e) Sunk cost; no effect. f) As in the answer to problem 4, this can be interpreted either as an increase in fixed costs or an increase in variable costs. Under the first interpretation, see Exhibit 7.20a; under the second, see Exhibit 7.20b. g) No change in the cost of operating a cab service, so no change in anything. h) Break-even price rises so price of cab rides rises and Gus supplies more rides. i Industry supply moves vertically up; price up; Gus supplies more rides. j Can be analyzed just as in 12c). k Industry supply moves vertically down so price of cab rides falls; Gus, either supplies fewer rides or exits. l Gus’s marginal cost curve rises; he either supplies fewer rides or exits. m Gus either makes the payment, which becomes a sunk cost and has no further effect, or leaves the industry. 13. a) Price does not change in the long run. b) More in the long run, because we are moving along a flat supply curve. c) Quantity does not change in the long run. d) Profits do not change in the long run. 14. a) Price does not change in the short run. b) Quantity does not change in the short run. c) Quantity does not change in the short run. d) Profits do not change in the long run. 15. a) Price does not change in the long run. b) More in the long run, because we are moving along a flat supply curve. c) Quantity does not change in the long run. d) Profits do not change in the long run. 16.

In both cases, the firm’s (flat) demand curve shifts $5 vertically upward. In Scenario A (a fixed cost) the firm’s supply curve doesn’t move. In Scenario B (a variable cost) the firm’s supply curve shifts leftward. Therefore the firm provides 7–22 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

fewer widges in Scenario B. 17. a) In the short run, the gift has no effect. So all that matters is the excise tax. This is an increase in a variable cost, so the picture is exactly as in Exhibit 7-9. b) The firm faces the same (flat) demand curve as before, but its supply curve is shifted left. Therefore each firm provides fewer shoes. Because the price is unchanged, demanders purchase the same number of shoes as before. Therefore the number of firms must increase. 18. a) Industry supply curves shifts rightward 800. Equilibrium quantity shifts rightward by less than 800; that is, more patients are served, but the increase is less than 800. b) In the long run, price must return to original level so quantity returns to original level. Thus private clinics serve exactly 800 fewer patients. 19.

The firm’s short-run supply curve is equal to its marginal cost curve. The industry’s short-run supply curve is derived from the firm’s marginal cost curve by multiplying all the quantities by 100 (the number of firms). So on the industry supply curve, a price of $2 goes with a quantity of 100, a price of $3 goes with a quantity of 200, etc. To find the point of equilibrium, we look for a point that is on both the industry’s (short-run) supply curve and the industry’s demand curve. That point occurs at a price of $5 and a quantity of 300. Thus each firm produces 3 widgets. Because the industry is in long-run equilibrium, each firm’s profit must equal zero. Now:

Profit = TR - TC = (3 × $5) − (Fixed Costs + Variable Costs) At quantity 3, variable costs are $2 + 3 + 5 = 10, so profit is $15 − (F C + 10). For this to equal zero, FC must equal $5. 20.

In the short run, this fixed cost has no effect. In the long run, the price of a widget must rise until firms can just break even given the new fixed cost of $5+11=16. Trial and error reveals that this occurs at the price of $8, where the firm produces quantity 5 (here T R = 8 × 5 = 40 and T C = 16 + 2 + 3 + 5 + 6 + 8 = 40.) At this price, 100 widgets are demanded, so in long run equilibrium there must be 20 firms producing 5 widgets each. Since there 100 firms to begin with, 80 must leave the industry.

21. a)

100

300

(Note: This is a stylized picture; the actual supply and demand curves are not straight lines.) Original equilibrium is at quantity = 300. New equilibrium must be at a point where the original supply and demand curves differ by $6. This occurs at quantity 100, where the demand price is $8 and the supply price is $2. So in the short run, the new widget price is $2. b,c) $11

300 We know from problem 19 that the long run supply curve is flat at the break-even price of $5. When demand drops vertically a distance $6, the price of a widget remains at $5. The price-plus-tax paid by demanders is now $11, at which price demanders want approximately 30 (somewhere between 25 and 50). Suppliers continue to supply 3 widgets each, so approximately 10 firms remain, meaning that approximately 90 firms must exit.

22. a)

$6 $5 $3

300

400

Original equilibrium is at quantity = 300. New equilibrium must be at a point where the original supply and demand curves differ by $3. This occurs at quantity 400, where the demand price is $3 and the supply price is $6. So in the short run, the new widget price is $3. b,c)

300

500

In the long run, the excise subsidy pushes the break even price down by $3, so the supply curve drops $3 and is now flat at $2. At this price, demanders want quantity 500. Each firm continues to produce quantity 3 (because firms continue to receive $5 per widget), so the total number of firms is 500/3, or approximately 167. Thus approximately 67 firms must enter.

23. a) Supply now crosses demand at price=$6, quantity=400. b) In the long run, a change in demand won’t change the price. 24. a) The equilibrium price for sales to foreigners is $15. At this price, foreigners buy 70 widgets, and 10 American firms supply 7 widgets each. b) The price of an export license will be bid up until each firm earns zero profit, just as firms that sell to Americans do. To compute profit, we need to know the firm’s fixed costs. We can do this by looking at the firms that sell to Americans. These firms produce 3 widgets per firm at a price of $7 each, so TR= $21. Their variable costs are $2+5+7=14, so their fixed costs must be $7. Now the firms that sell to foreigners sell 7 widgets each at $15 for total revenue of $105. Their variable costs are $2+5+7+9+11+ 13+15=62, so their total fixed costs must equal $43. In other words, their fixed costs are $36 greater than for firms that sell to the American market. That $36 must be accounted for by the price of the license. c) Initally, each firm sells 3 widgets and 75 widgets are demanded; thus there are 25 firms. Of these, 10 switch over to serving foreigners, so we are left with 15 firms in 7–25 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

the American market. Thus to get points on the short-run supply curve, we must multiply quantities on the firm’s short-run supply curve by 15. This tells us that on the new short-run supply cure, the price of $9 goes with a quantity of 60; this point is also on the demand curve. So that’s the new equilibrium. d) In the long run, firms enter the American market until the original equilibrium is restored. Thus the price returns to $7. 25. False. They seek to maximize profit, period. In long run equilibrium, assuming a constant cost industry, average cost is minimized, but this is not the goal of any firm. 26. a) Exactly 50 cents because flat supply curve drops 50 cents. b) Less than 50 cents because upward sloping supply curve drops 50 cents. 27.

In Upper Slobbovia, the entire tax is passed on; in Middle Slobbovia, a portion of the tax is passed on; in Lower Slobbovia, none of the tax is passed on.

28.

True. The long run supply curve shifts vertically upward by the amount of the tax. The new equilibrium point is to the left of the old one, and consequently higher than the old price plus the tax.

29.

False. The first year’s entry causes the short run supply curve to shift rightward. Therefore the price will be below its original level.

Answers to Numerical Exercises N1.a) Each firm produces 5 widgets, earning revenue of $50, with total cost $36. Profit is $14, which is positive, so the industry is not in long run equilibrium. b) Positive profit draws entry till te price falls to $6, where each firm produces 3 widgets and profit is zero. N2.

The price is $15. At this price, each firm produces 3 widgets and earns zero profit. Consumers demand 450 widgets so there are 150 firms in the industry. At a price of $10, each of 150 firms would produce 2 widgets, so the quantity on the short run supply curve is 300.

N3.a) $20 (the price at which profit is zero) b) 150 (the quantity demanded divided by the quantity supplied per firm) c) Prior to the tax, the short-run supply curve contains points ($5, 150), ($10,300),($15,450), etc. With the tax, the short-run supply curve shifts vertically upward $15 and now contains points ($20,150),($25,300), etc. The point ($25,300) is on both the supply and demand curves, so it is the new equilibrium. The price is $25. d) No firms leave in the short run. e) In the long run, price must rise by the full amount of the tax, from $20 to $35. f) Each firm provides 4 widgets. 140 widgets are demanded. Therefore the number of firms must fall from 150 to 140/4=35. So 115 firms leave the industry. N4.a) At a price of $20, total cost and total revenue each equal $80. So $20 is the break-even price, and this is the price of a widget. b) Each firm produces 4 widgets; 600 are sold, so the number of firms is 600/4=150.

c) Each firm’s supply curve shifts a distance $15, so the new supply curve is given by Price $20 25 30 35 40

Quantity 1 2 3 4 5

With 150 firms, this gives an industry-wide supply curve of Price $20 25 30 35 40

Quantity 1 300 450 600 750

$25 is now the price at which quantity supplied equals quantity demanded, so this is the new price of widgets. d) Nobody leaves the industry in the short run. e) The (flat) long-run supply curve shifts upward $15, so the new price is $35. f) Firms get to keep $20 per widget, so they supply 4 widgets each; 140 must be supplied altogether, so there are now 140/4=35 firms. Thus 115 leave the industry. N5.a) The break-even price is $7; at this price each firms’ total revenue and total costs are both equal to $28. b) Each firm produces 4 widgets. c) The industry-wide quantity is 24, so there must be 6 firms. d) The industry-wide supply curve is Price Quantity $2 6 4 12 5 18 7 24 11 30 13 36 This crosses industry-wide demand at a price of $13, so that is the new equilibrium price. At that price, each firm produces 6 widgets. d) In the long run, the price must return to the break-even level of $7. At that price, consumers demand 60 widgets, and each firm produces 4, so there must be 15 firms. N6.

The equilibrium price is $5. At that price, there are 80 firms in the industry, each with fixed costs of $10 and total costs of $25. Also, each firm has a total revenue of $25, so profits are zero.

N7.a) Profit maximization requires P = M C. Zero profits requires P = AC. Thus M C(Q) = AC(Q), where Q is the number of kites each firm produces. From the expressions given in the problem we get 2Q = Q +

100 , Q

so that Q = 10 and consequently P = 20. That is, each firm produces 10 kites and earns zero profit when P = 20. Consequently the long run industry supply curve is flat at P = 20. 7–27 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied or duplicated, or posted to a publicly available website, in whole or in part.

b) Since P = 20, we can solve for the equilibrium value of Q and get Q = 7000. The industry produces 7000 kites, of which 10 are produced at any given firm. It follows that there are 700 firms in the industry. c) In the short run, supply is fixed at Q = 7000. Solving for the equilibrium price, we get P = 40. Each kite maker supplies 10 kites at an average cost of 20 and sells them at a price of 40, for a profit of 20 per kite or 200 per firm. d) The new long-run equilibrium Q is 8000, so there must be 800 firms, of which 100 are new. All firms earn zero profit. N8.a) Fire extinguishers are a fixed cost, so M C does not change. The cost of a fire extinguisher is equal to the number of fire extinguishers, which equals the number of firms, so each firm’s T C is up by √ F , and consequently √ AC is up by F/Q. b) Solving for M√C = AC, we get Q = 100 + F , P = 2 100 + F . c) Since√P = 2 100 + F , we get F = P 2 /4 − 100. Each of the F firms produces Q = 100 + F = P/2 kites, so the industry supply is Q=

P2 P P3 − 100 · = − 50 · P. 4 2 8

d) Using the above expression for industry supply and solving for the equilibrium gives P = 40, Q = 6000. Each firm produces 20 kites, so there are 300 firms in all. They earn zero profit.