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Merceda Gooding

Microeconomics

November 6, 2011

Office building maintenance plans call for the stripping, waxing, and buffing of ceramic floor tiles. This work is contracted out to office maintenance firms, and both technology and labor requirements are very basic. Supply and demand conditions in this perfectly competitive service market in New York are: QS = 2P - 20 QD = 80 - 2P (Supply) (Demand)

Where Q is thousands of hours of floor reconditioning per month, and P is the price per hour.

QD = QS 80 2P = 2P 20 100 = 4P 25 = P

Q* = = = Q =

80 2P 80 - 2(25) 80 - 50 30

P = 25 and Q = 30 is the equilibrium price/output combination. The graph below illustrates the equilibrium price and the supply/demand curve.

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The figure below shows a firm in a perfectly competitive market:

A. Find the price below which the firm will go out of business. (The firms minimum average variable cost, is the shut down point for the perfectly competitive firm (P2= AVC). The figure above of a perfectly competitive market show the output level of 10 quantity (per day) where P3 (C ) equals average total cost. The market to P2 (B) the firm will now produce output 8 quantity (per day) because that is the output level where the new price P2 is below the average total cost. The firm is now earning negative economic profits or suffering losses by producing output level 8 quantity (per day); only enough to cover its average variable cost (P2=AVC) but not covering it fixed cost. The price falls from P2 to P1 or below the managers should shut down and go out of business; losing only fixed cost. However, if it continues to operate the firm can lose both variable and fixed cost. B. What is the firms long run supply curve? The supply curve shows a one to one relationship between the product price and quantity output. The firm is willing to supply that portion of the firms marginal cost curve about the minimum average variable cost. The long run supply curve is flatter and more elastic slope upward. Because the entry and exist a higher price attracts new entrants in the long run, resulting a rise in the firms output and lower price. A fall in price induces existing producer to exit in the long run decrease in output. Because the firm is a price taker it must accept the new equilibrium price and determine the level of output that maximizes profit at the new price. P4 is greater than the average total cost and the output 11 quantity (per day) that will illustrate economic profits. The long run allows for the new firms to enter the market and the existing firms will exit the market. (In a perfect competitive market there are no barriers to entry of exit the firms). Existing firms may choose to leave the market if they are earning losses; the firms in a perfectly competitive market may not change in the long-run.