Question

The market for monkey spanners currently has 10,000 firms that have identical size and production technology.

a. The market is currently in a long-run equilibrium where each firm produces profit-maximizing quantity of monkey spanners at the lowest average production cost. Illustrate the situation for an individual firm and the one for the monkey spanner market.

b. They recently found a serious problem in the kitchen sink drain pipes in many of the houses built after 2005, which resulted in a shift of the demand curve for monkey spanners (to the right). What will be the short run effects of this event on the price and quantity of monkey spanners?

c. If new entry is allowed in the monkey spanner market, what will be the longrun consequence of this event on the price and quantity of monkey spanners? Assume that firms newly entering the market use less efficient production technology, so their overall production costs are higher than the incumbent firms. Can you derive the long run supply curve in the market? Is it perfectly (horizontal) or imperfectly elastic (positively sloped)

Answer 1

a. b. Shift in the demand curve will result in increase in the price level in the period of short run. Howeverr, this increase in the price level will not stay longer for new firms may enter driving down the price level back to p₁(the minimum point of ATC). The output will also return to q₁.

c. The long run supply curve is upward sloping curve.