Question

3) Perfectly competitive markets

# of contraptions total cost

0 500

1   580

2 640

3 690

4 730

5 760

6 800

7 850

8 950

9 1200

10 2000

a) Calculate the marginal cost for contraptions, given the above information, add it to your Table, and graph it.

b) Where does diminishing returns set in? Explain how you know.

c) If market price equals $100, how many units should be produced? What is revenue? What is profit? Add these columns to your Table too.

d) What is the fixed cost? Would the number of units produced change if the fixed cost went down? Why or why not?

e) Firms now exit the contraption market, and contraption price goes up to $250. Graph this result, showing market and firm graph side by side. How many units will a firm with the above cost function produce? What will profit be? (It might be helpful to show a new Table or at least add a couple of columns to the existing one).

f) At this point, will more firms exit, or will new firms start to enter the market? Explain.

**g) EXTRA CREDIT: What is the long run equilibrium price? What is profit? (Show all calculations) Why will firms not leave the market?

Answer 1

Q	TC	MC
0	500
1	580	80
2	640	60
3	690	50
4	730	40
5	760	30
6	800	40
7	850	50
8	950	100
9	1200	250
10	2000	800

b) Diminishing returns sets in when the firm produces Q = 6th unit because marginal cost of producing the unit increases

C)

Q	TC	MC	TR	PROFIT
0	500		0	-500
1	580	80	100	-480
2	640	60	200	-440
3	690	50	300	-390
4	730	40	400	-330
5	760	30	500	-260
6	800	40	600	-200
7	850	50	700	-150
8	950	100	800	-150
9	1200	250	900	-300
10	2000	800	1000	-1000

Setting P=MC, the firm should produce Q = 8 units

d) Fixed costs = 500

The firms decision does not depend upon the changes in the fixed cost as it is regarded as sunk cost. The firm makes its decision based on its variable costs.