National University of Singapore

Department of Economics

EC2101 Microeconomic Analysis I

Semester 1 AY 2014/2015

Practice Problems 8 Solution

Long-Run Perfect Competition
Presentation schedule: Two student presentations; one student presents Question 1,
and Question 2, and one student presents Question 3 and Question 4.
Question 1 Suppose the market for a type of mineral is perfectly competitive,
characterized by price-taking firms and free entry and exit. All producers are identical
and currently they have the following short-run average total cost curve,
SAC(Q)=2Q+648/Q. Moreover, the short-run average total cost curve given above is
also the one that touches the long-run average total cost curve of a typical firm at its
minimum. Any potential entrant into the market would also have the same cost
curves. The market demand curve for the mineral is D(P)=2340-20P. Currently, there
are 24 firms in the market.
a) What is the short-run equilibrium price of the mineral? What is the short-run
equilibrium quantity of the mineral?
The short-run total cost curve is STC(Q)=SAC(Q)Q=2Q2+648. Thus the short-run
marginal cost curve is SMC(Q)=4Q. To maximize profit, each firm should produce at
P=SMC, thus P=4Q. Since AVC(Q)=2Q, the minimum level of the AVC is 0, thus
each firms supply curve is Q=P/4. Since there are 24 firms in the market, the market
supply curve is S(P)=6P. Equating the supply curve to the demand curve, we have
6P=2340-20P, thus P=90. The equilibrium quantity is Q=6*90=540.
b) What is the long-run equilibrium price in this market? How many potential entrants
will enter the market in the long-run equilibrium?
Since the short-run average total cost curve given is the one that touches the long-run
average total cost curve at its minimum, the minimum level of this short-run average
total cost curve is the minimum level of the long-run average total cost curve. At the
minimum point, SAC=SMC=LMC=LAC. Using SAC=SMC, we have 2Q+648/Q=4Q.
Thus when Q=18, the minimum level of long-run average total cost is reached, and it
is 4*18=72. Since all firms are identical, the long-run equilibrium price is 72. In the
long-run equilibrium, each firm produces 18 units, the total quantity demanded and
supplied in the market is 2340-20*72=900. Therefore, the number of firms in the
market is 900/18=50. Since the market has only 24 firms in the short run, there will be
26 firms entering the market in the long run.
Question 2 Suppose that the world market for calcium is perfectly competitive and
that, as a first approximation, all existing producers and potential entrants are
identical. Consider the following information about the price of calcium:
Between 1990 and 1995, the market price was stable at about $2 per pound.
In the first three months of 1996, the market price declined to $1 per pound,
where it remained for the rest of 1996.
Throughout 1997 and 1998, the market price of calcium increased, eventually
reaching $2 per pound by the end of 1998.
Between 1998 and 2002, the market price was stable at about $2 per pound.
Assuming that the technology for producing calcium did not change between 1990
and 2002 and that input prices faced by calcium producers have remained constant,
1

National University of Singapore

Department of Economics

EC2101 Microeconomic Analysis I

Semester 1 AY 2014/2015

what explains the pattern of prices that prevailed between 1990 and 2002? Is it likely
that there are more producers of calcium in 2002 than there were in 1990? Fewer?
The same? Explain your answer.
The scenario described in the problem can be explained as a constant-cost perfectly
competitive industry that experienced a decrease in demand (i.e., leftward shift in the
demand curve) in early 1996. The price between 1990-1995 reflects a market that is in
long-run equilibrium. The decrease in price in early 1996 reflects the movement to a
short-run equilibrium following the decrease in demand. Once price stabilizes at the
new short-run equilibrium, firms in the market earn negative economic profits, so
they will start to exit the industry. As exit occurs during 1997 and 1998, the short-run
supply curve shifts leftward, causing price to rise. The incentive for exit disappears
once price is reestablished at the minimum level of long-run average cost for a typical
firm, $2. As a result of the decrease in demand, the market now contains fewer active
producers in 2002 than it did in 1990.
Question 3 The long-run total cost function for producers of mineral water is
TC(Q)=cQ, where Q is the output of an individual firm expressed as thousands of
liters per year. The market demand curve is D(P)=abP. Find the long-run
equilibrium price and quantity in terms of a, b, and c. Can you determine the
equilibrium number of firms? If so, what is it? If not, why not?
The long-run average cost curve is LAC(Q)=c. Thus min(LAC)=c, which is the longrun equilibrium price. The total quantity demanded in the long-run equilibrium is then
a-bc. For each firm, the long-run marginal cost is also LMC(Q)=c. Thus both the
long-run marginal cost curve and the long-run average cost curve are flat. At the longrun equilibrium price, the firm can produce any quantity. Since we cannot determine
the quantity each firm produces, we cannot determine the number of firms in the
market.
Question 4 Suppose the market for catfish in the US is perfectly competitive. All
existing producers and potential entrants are identical. Below is a summary of the
price and quantity evolution in this industry between 2000 and 2008:
Between 2000 and 2002, the industry is in a long-run equilibrium.
o Market price: $3 per pound
o Total quantity demanded and supplied: 100,000 pounds
o Each firm supplies: 1000 pounds
o Number of firms: 100
In 2003, an unexpected exogenous shock occurred that affected prices and
quantities in the market. Four months after the shock, the market is in a shortrun equilibrium.
o Market price: $4 per pound
o Total quantity demanded and supplied: 120,000 pounds
o Each firm supplies: 1200 pounds
o Number of firms: 100
In 2008, the market reached a new long-run equilibrium.
o Market price: $2.5 per pound
o Total quantity demanded and supplied: 165,000 pounds
o Each firm supplies: 1100 pounds
o Number of firms: 150
2

National University of Singapore

Department of Economics

EC2101 Microeconomic Analysis I

Semester 1 AY 2014/2015

The shock in 2003 might have something to do with either a change in the market
demand for catfish or a change in the market supply for catfish. Which shock most
likely explains the price and quantity dynamics in the catfish industry between 2000
and 2008? Is this industry a constant-cost, increasing-cost, or decreasing-cost
industry? Explain your answer.
The shock in 2003 is most likely a rightward shift in the demand curve. Four months
after the shock, in the short-run equilibrium, market price is higher and total quantity
is also higher, suggesting an increase in demand.
Because the short-run market equilibrium price ($4) is higher than the minimum of
LAC for each firm ($3), there will be entry. As new firms enter the industry, the shortrun market supply curve will shift to the right, causing the market price to fall.
Eventually, in the new long-run equilibrium, there are 50 new firms, and the total
quantity in the market is 165,000, higher than the 120,000 in the short-run
equilibrium. However, the long-run equilibrium price is $2.5, lower than the long-run
equilibrium price of $3 in 2000. This suggests that the catfish industry is a decreasingcost industry. As the market expands, input prices decrease, making production less
costly for each firm and potential entrant. The cost curves of each firm will shift
down. Thus the minimum level of the LAC for each firm drops to $2.5.