Consider a market where demand is described by =1406. An individual firm in this market can supply quantity =2 in the short run, for any price above 2. (Quantities are in thousands of units per year, prices are in US dollars per unit.)

a. If only two firms exists in the market and they act competitively, find the equilibrium price and quantity, and calculate producer and consumer surplus. If you know firms earn zero profit, what must their fixed cost be? (recall that in the short run = and assume as usual in the competitive model that firms have identical costs)

b. Calculate the elasticities of market supply and market demand at the equilibrium point. Which one is more elastic?

c. Now suppose demand for this good jumps to =2206. What will happen in this market immediately afterwards? (i.e. before price has the chance to adjust) Draw a graph, showing the relevant quantities and surpluses. Show whether either producer or consumer surplus increase.

d. Continuing from part c, evaluate what happens as price adjusts. By how much do the quantities supplied and demanded change? Does total surplus increase (assuming no externalities)? [Note that we are still in the short run, so new firms are not able to enter the market.]

e. Suppose that long-run firm-level supply in this market is the same as short-run supply, however the long run allows more firms to enter (and existing firms to potentially exit). Assuming that there are no barriers to entry (or exit) and that demand stays at the new level from part (c), find how many firms will be in the market in the long run competitive equilibrium.

f. What would have happened if a price ceiling had been introduced immediately after the jump in demand, in order to keep price from going above the original level? List and discuss the consequences in the market in the short run. What is a key issue regulators would need to address? If the price ceiling remains in effect, can you tell how many firms will be in the market in the long run equilibrium?

g. Repeat part f, this time assuming that the price ceiling had been set to $2 above the original equilibrium. Draw a graph and describe both the short run and the long run.