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1.

J&P Company operates in a perfectly


competitive market for smoke alarms. J&P
is currently earning short-run positive
economic profits.
(a) Using correctly labeled side-by-side graphs
for the smoke alarm market and J&P
Company, indicate each of the following
for both the market and the J&P Company.
(i) Price
(ii) Output
Perfectly competitive with economic profits
(a) Side-by-side graph (market and firm)
(i) Price
(ii) Output
S
MC
0
D
P
Q
P
MR=D=AR=P
q
e
(b) In the graph in part (a) for J&P, indicate
the area of economic profits that J&P
Company is earning in the short run.
S
MC
0
D
P
Q
P
MR=D=AR=P
q
f
g
TR = 0Peq
TC = 0gfq
Economic Profit = gpef
e
(c) Using a new set of correctly labeled side-by-
side graphs for the smoke alarm market and
J&P Company, show what will happen in the
long run to each of the following.
(i) Long-run equilibrium price and quantity
in the market
(ii) Long-run equilibrium price and quantity
for J&P Company
(c) side-by-side graphs in the long run
(i) Long-run equilibrium price and quantity
in the market
S
MC
0
D
P
Q
P
MR=D=AR=P
q
f
g
e
In the long run, firms will enter the market
causing the supply curve to shift to the right.
S1
Market price will decrease.
P1
Market Q will increase.
Q1
(c) side-by-side graphs in the long run
(ii) Long-run equilibrium price and quantity
for J&P Company
S
MC
0
D
P
Q
P
MR=D=AR=P
q
f
g
e
S1
P1
Q1
Since J&P Company is a price taker it will take
the market price.
P1
J&P Co. price goes down.
J&P now produces where the new MR1 = MC.
MR1=D1=AR1=P1
q1
J&P Co. quantity decreases.
(d) Assume that purchase of smoke alarms create
positive externalities. Draw a correctly labeled
graph of the smoke alarm market.
(i) Label the market equilibrium quantity
as Qm
(ii) Label the socially optimum equilibrium
quantity as Qs
(d) Assume that purchase of smoke alarms create
positive externalities. Draw a correctly labeled
graph of the smoke alarm market.
(i) Label the market equilibrium quantity
as Qm
(ii) Label the socially optimum equilibrium
quantity as Qs
S
D
Pm
Qm
Price
Quantity
(d) Assume that purchase of smoke alarms create
positive externalities. Draw a correctly labeled
graph of the smoke alarm market.
(i) Label the market equilibrium quantity
as Qm
(ii) Label the socially optimum equilibrium
quantity as Qs
S
D
Pm
Qm
D2 = MSB
Qs
Ps
Price
Quantity
(e) Identify one government policy that could be
implemented to encourage the industry to
produce the socially optimum level of smoke
alarms.
Subsidize sellers or buyers.
Mandatory smoke alarm system.
Tax relief.