Handout 10 Perfect Competition – Short-run Behavior, Breakeven, and Shutdown This handout contains exercises of - Profit Maximization in Perfectly Competitive Market Things you should know - What are the characteristics of firms in perfectly competitive market? - How to find the firm’s behavior and quantity to produce that maximizes its profit? Exercises Question 1 (Review of Production and Cost Functions, and Profit Maximization) Suppose each worker costs $100 to hire. An example firm has the following production and cost schedule. L Q MPL TC MC … … … … … 10 200 20 1200 2.5 60 (a) 16 (b) 6.25 (d) 1800 (e) (c) 10 1. Fill in the blanks (a), (b), (c), (d), and (e). Then find the amount of fixed cost for this firm. 2. If the market price is $10, this firm should [ produce _______ units / shut down ] to maximize the profit of $_________. If the market price is $2.5, this firm should [ produce _______ units / shut down ], the profit is $_________. Question 2 (Profit Maximization in the Short-run) The graph below shows the production cost curves of a firm in a perfectly competitive industry. 1. What is the amount of fixed cost for this firm? 2. If the current market price is $30, what is the quantity this firm should produce? Will the firm make (economic) profit or suffer loss? How much? Should the firm shut down? 3. What is the break-even price for this firm? What is the shut down price for this firm? 4. Suppose this firm is fined by $1000 due to pollution violation while the market price remains the same at $30, this results in the average variable cost to [ increase / remain unchanged ], the average total cost to [ increase / remain unchanged ], and the marginal cost to [ increase / remain unchanged ]. Therefore, this firm should [ produce 35 units / shut down ]. 5. (Bonus) Revert to the original scenario, figure out what is the total variable cost when the output is 40 units. 1 Question 3 (Equation Questions for Shutdown and Breakeven Points in the Short-run) Consider the following production cost information of a firm Total cost: TC = q2 + 5q + 25 Marginal cost: MC = 2q + 5 Average total cost: ATC = q + 5 + 25/q What is the breakeven price? What is the price below which the firm should shut down its operation? (Hint: You still need to find total variable cost) Question 4 (Equation Questions for Short-run vs. Long-run) Continuing from Question 3, assume that all firms – incumbent and prospective entrant – have the same cost structure Total cost: TC = q2 + 5q + 25 Marginal cost: MC = 2q + 5 Average total cost: ATC = q + 5 + 25/q Furthermore, the market demand is given by P = 105 – Q 1. If the current market price is $45, what is the quantity each firm should produce to maximize its profit? 2. What is the size of the industry with current market price of $45? That is, how many firms are there in the short-run? 3. Given the current market price of $45 in the short-run, the profit of each firm is positive. What do you expect to happen in the long-run? 4. What is the breakeven price of each firm? 5. If there are new firms entering the industry in the long-run, what is the quantity produced by all firms in the market? 6. How many firms are there in the industry in the long-run and how many units each firm is producing? 7. Given the number of firms in the long-run found in above sub-question, what is the industry supply curve? 2