Handout 11 Perfect Competition – Long-run Behavior, Exit, Long-run Average Cost, Market Supply Curve This handout contains exercises of - Long-Run Average Cost Curve - Profit Maximization of Perfectly Competitive Firms in the Long-Run Things you should know - What are the characteristics and adjustments of firms in the long-run? - What are the characteristics of firms in perfectly competitive market in the long-run? - How to find the firm’s behavior and quantity to produce that maximizes its profit? Exercises Question 1 (Profit Maximization in the Long-Run) In a perfectly competitive industry, all firms face the cost structure and market demand as depicted below. 1. If the current market price is $5, then each firm will produce ________ units, and there are ________ firms in the industry. 2. What is the long-run equilibrium number of firms in this industry? What is the quantity produced by each firm in this long-run equilibrium? Question 2 (Short-Run vs. Long-Run: Conceptual Question) Each worker (L) costs $10 to hire, each unit of capital (K) costs $10 to rent. The following table denotes the combinations of capital and worker mixes for a representative firm to produce certain quantities of good: Q L K TC AC 100 20 20 400 200 60 20 800 200 30 30 600 1. What should a firm do in the short-run if it wishes to increase the production from 100 units to 200 units? Why? 2. What should a firm do in the long-run if it wishes to increase the production from 100 units to 200 units? Why? 3. Relate the difference between short-run and long-run average cost curves in light of answers in part 1 and 2. 4. Can you tell if the firm is experiencing increasing, decreasing or constant returns to scale? 1 Question 3 (Long-Run Average Cost Curves and Profit Maximization) Each firm has the ability to choose Scale 1 or Scale 2, denoted by MC1, AC1 and MC2, AC2, respectively. Consider the industry demand-supply curve and the cost structure of a representative firm and answer the following questions: 1. Suppose the current market price is $15, then each firm would produce ________ units, and there are ________ firms in the industry. Each firm earns an economic profit of ___________. 2. What would happen in the long-run? 3. How many firms are there in the long-run? 2