EC 201 Student Name:

Cal Poly Pomona Section:

Dr. Bresnock

Fall, 2011

Competition Module Assignment Answers (50 points) Due: Nov.28th

Please limit your answers to the spaces provided. If necessary, write on the back of the page. Do not attach printout or additional pages. All questions pertain to the Competitionmodule inSimEcon. Make sure you have read the “Competition Manual” which may be found on the ClassWeb site prior to beginning the assignment. For many of the assignment's questions, it will be necessary to refer to those instructions. For many of the assignment's questions, it will be necessary to refer to your text. Please use this website to obtain the module:

and if that site isn’t working, then you can also use

Note that this exercise and module provides an example of a perfectly competitive firm and market, so all the usual assumptions of this model apply. Open the Competition module of SimEcon®. You will see a table called Firm’s Short Run Costs. Print out a copy of this table for your own use. It will be useful throughout the exercise.

If the price of the product is $18.00 per unit, what output should the firm produce? 10,000 units. If the price of the product is $0.40 per unit, what output should the firm produce? 0 units. What principles do you use to arrive at these answers? In the first case the principle is that the profit-maximizing level of output is where marginal cost equals price. In the second the principle is that price must exceed average variable cost at the output where MC equals price or the firm should shut down. (You can read the relevant data from the table of the firm’s short run costs.)

If the price of the product is $64.40 per unit, and the firm is producing 14,000 units of output, is the firm incurring an economic (above normal) profit or loss? Economic profit. In this case, is the firm incurring an accounting profit or loss (as recorded on the income statement)? Accounting profit. What is the economic profit (or loss) per unit? $46.45 per unit.

If the price of the product is $9.00 per unit, and the firm is producing 10,000 units, is the firm incurring an economic profit or loss? Economic loss. What is the economic profit (or loss) per unit? Economic loss of $0.60 per unit. Is the firm producing the output that maximizes profit (or minimizes loss) given the stated conditions? No (Yes, No). Is it possible that the firm could be earning an accounting profit, i.e., a net income on its income statement? Yes (Yes, No).

Now, click “Continue”. Manually select a current market price of $7.57 and click “Continue”. Select an output of 9,000 units, and click “Results”. Using the table labeled “Firm Results”, write down the price of the product and the marginal cost below:

Price = $7.57Marginal Cost = $10.90

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Competition Module Assignment Answers

Is this firm maximizing profit (or minimizing losses) at this output level? No (Yes, No). What relevance do price and marginal cost have on this question? Since marginal cost is greater than the marginal revenue, the additional cost of producing the last unit is greater than the additional revenue of producing it. Lowering production will reduce the firm’s losses.

Using the “Firm Results” table, write down the quantity, the price, the average total cost, and the average variable cost of this product:

Quantity: 9,000 unitsPrice: $7.57ATC: $9.08AVC: $7.30

What is the total revenue at this price and output level? $68,130. What is the marginal revenue? $7.57. What is the average revenue? $7.57. What are average fixed costs at this price and output level? $1.78. What are total fixed costs at this price and output level? $16,020. Is the firm incurring an economic profit or loss? Economic loss. What is the economic profit (or loss) per unit? Economic loss per unit = $1.51. Is it possible that the firm could be earning an accounting profit, i.e., a net income on its income statement? Yes (Yes, No). Should this firm shut down in the short run? No. Why or why not? Because the price is greater than average variable cost so by producing the firm loses less than its fixed cost.

Click “Firm Graph”. In the space below, draw the graph that you see on your screen. Is the firm producing the output that maximizes profit given the stated conditions? No (Yes, No). If the firm is not maximizing profit, does the firm need to increase or decrease output? It needs to decrease output. How does the graph show this? The dotted vertical indicates the current level of output, Q*. The firm needs to get to the point where the MC line crosses the P = MR line. This is where MC = P and where profit is maximized or where loss is minimized. Thus, the firm needs to decrease output. Which point on the graph indicates the profit-maximizing or loss-minimizing level of output? The point where MC = P, which is where the MC line crosses the P = MR line.

FIRM

$ MC ATC

AVC

P = MR = AR

Q

Q*

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Competition Module Assignment Answers

Now, click the “Back” button twice. The price of the product should be the same as before. Otherwise, you will have to start from scratch. Given the work that you have already done, should the output level increase, decrease or remain the same? Decrease.

To get an estimate of where the profit maximizing output is consult the table entitled “Firm’s Short Run Costs” that you printed out earlier. What must price be equal to in order to maximize profits? Marginal cost.

Keeping the price at $7.57 continue to enter new output levels until you think that you have arrived at the output level that will maximize profits (or minimize losses). Using the “Firm Results” table, write down the quantity, the price, the average total cost, and the average variable cost of this product. Use the output that maximizes profits.

Quantity: 8,412 or 8,413 units Price: $7.57ATC: $9.074AVC: $7.169

What is the total revenue at this price and output level? $63,678.84 with 8,412, or $63,686.41 with 8,413. What are average fixed costs at this price and output level? $1.905. Is the firm incurring an economic profit or loss? Economic loss. What is the economic profit (or loss) per unit? Economic loss of $1.50 per unit. Is it possible that the firm could be earning an accounting profit, i.e., a net income on its income statement? Yes (Yes, No).

How does total revenue from this output level compare to the total revenue from 9,000 units of output? There is less total revenue from this output level. How does the profit (or loss) from this output level compare with the profit (or loss) from 9,000 units of output? The total economic loss is slightly lower at this output level. Must the output level that produces the most revenue necessarily be the output level that maximizes profits (or minimizes losses)? No. Why or why not? You also have to consider per unit costs and total costs to arrive at the maximum profit or minimum loss. Total revenue will keep rising as long as production increases, that is not true for profit.

If profit is maximized or loss is minimized for this year only, does that mean that firm equity over the life of the firm will also be maximized? No (Yes, No). Why or why not? We are only considering one year of profits. Firm equity represents the accumulation of profits over many years and is maximized in the long run.

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Click “New Price” and “Set the Price Manually.” Click “Continue”. Select a price of $6.10 per unit. Click “Continue”. Continue entering new output levels until you arrive at the profit maximizing or loss minimizing output. Considering the price and the table of the firm’s short run costs, what output do you think will maximize profits (or minimize losses)? $8,111. Fill out the table of firm results indicated below:

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Competition Module Assignment Answers

Price:$6.10Profit Margin:$-3.058

Output:8,111 unitsTotal Profit:$-24,802.016

ATC:$9.158MC:$ 6.099

AVC:$7.181

Is MC exactly equal to price? No (Yes, No) Is this the profit maximizing output? Yes (Yes, No) Explain your answer. This output gives the best profit available, getting MC exactly equal to price means producing an amount between 8111 and 8112 and that cannot be done.

Compute the following results for this scenario. Show formulas and computations:

Total Fixed Costs: (ATC – AVC) * Q = (9.158 – 7.181) * 8,111 = $16,035.447

Total Variable Costs: AVC * Q = 7.181 * 8,11 = 58,245.091

Total Costs: ATC * Q = 9.158 * 8,111 = 74,280.538

Marginal Revenue = Price: $6.10

Click “Firm Graph”. Draw the graph of the firm below. Show both the firm graph and the market graph provided by the module.

$MC ATC P SSR

AVCSLR

PSR

D

QE Q QE Q

FIRMMARKET

Given these results, is this firm in the long run or the short run? Short run. How can you prove this? The results indicate the presence of fixed costs. In the long run, all costs are variable.

What is the shutdown price for this firm? $7.181. This is because, if the price falls below $7.181, it will not even be able to cover its variable costs. Given the current price and quantity, should this firm shut down? Yes (Yes, No).

Since this is a perfectly competitive market, what must the average revenue be equal to? Price. Can this firm influence the price by increasing or decreasing output? No (Yes, No). What is your reasoning behind your answer? In a perfectly competitive market, there are so many

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Competition Module Assignment Answers

buyers and sellers than no one buyer or seller can affect the market price. The firm is a “price taker”.

How many firms and how many buyers are in this market? In a perfectly competitive market, there are an infinite number of buyers and sellers.

Consult the table, “Firm’s Short Run Costs” that you printed out earlier. If this is a constant cost firm and industry and this firm and market were in a state of long run competitive equilibrium, approximately what output should the firm be producing? 8,000 units. Why is this the output for the long run equilibrium? In the table the ATC at 8000 units has the lowest value. If this is really the lowest unit cost the firm has in the short run—and it has constant long run unit costs as do all the other firms—then $9.20 would be the long run equilibrium price and in the long run that would be the firms marginal cost. Therefore at 8000 units in the long urun MC equals price and profit is maximized.

In this long run competitive equilibrium, assuming that there are no shocks to the market, what will be the relationship between the number of firms entering the market and the number of firms leaving the market? The number of firms entering the market will approximately equal the number of firms leaving the market.

If suddenly there was a wage increase that raised production costs in this market, other things being equal, what would happen to the number of firms entering versus the number of firms leaving this market? Give reasons. Since production costs are being driven up, many firms will be earning economic losses, so there will be a relative exodus of firms from the market. More firms will be leaving the market than entering until a new long run competitive equilibrium is achieved.