Question

Suppose that the local market for ice cream is competitive and that all ice cream parlors are identical

A. Using graphs, illustrate a short-run equilibrium in the market in which ice cream parlors are earning a positive profit. Your graphs should show the market equilibrium price and quantity as well as the price, quantity, marginal cost and average total cost of a typical café.

B. Using your graphs, explain why every ice cream parlor will produce the quantity for which average total cost is minimised in the long run.

Answer 1

A)

Over the short run firm can earn the positive economic profit. Firm can earn the super normal profit.

Here, price is greater than the average cost of production. Following is the diagram:

b)

Supernormal profit in the short run would incentivize entry of new firms in the market. Therefore market supply rises and price declines. New entry keeps on happening until the price becomes equal to the the average cost of production. At the equilibrium point the average cost is equal to marginal cost. The average cost is minimum where it intersect with marginal cost of production. Therefore over the long run firm gets only normal profit and operates at the the minimum point of average cost of production. Therefore firm is productively efficient.