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Equilibrium Price and Quantity in Perfect Competition

The perfectly competitive firm takes the equilibrium price set by the market and maximizes profit by producing where price, which also equals marginal revenue, is equal to marginal cost. The level of profit earned depends on the relationship between price and average total cost. Graph the perfectly competive industry of market. Graph the perfectly competitive individual firm. Note that the perfectly competitive market is initially in long-run equilibrium with price equal to P1. Assume now that there is an increase in demand for the good produced in this market. Draw a new market demand curve that illustrates this change and lable it D2. Also, draw the new demand curve for the firm and lable it MR2=D2. Is the firm now making economic profit? Given the change in demand described, over time what will happen to the number of firms the industry? As this change takes place, what will happen to the industry supply curve? Draw the new industry supply curve that is consistent with long-run equilibrium in the market and lable it S2. After the market has once again adjusted to long-run equilibrium, market price is (what ?) and economic profit for the firm is equal to (what ?)

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Solution:

The perfectly competitive firm takes the equilibrium price set by the market and maximizes profit by producing where price, which also equals marginal revenue, is equal to marginal cost. The level of profit earned depends on the relationship between price and average total cost. Graph the perfectly competitive industry of market. Graph the perfectly competitive individual firm. Note that the perfectly competitive market is initially in long-run equilibrium with price equal ...

Solution Summary

Solution studies the behaviour of perfectly competitive market and a firm in the short run. It also analyzes the effect of increased demand on equilibrium position. Long run adjustments are studied. Concepts are explained with suitable graphs.

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