Poin 4) In the B.3-1: Equilibrium Adjustments Facing Shocks, Long-run Supply Curve for an ICI: Now, let's drop the constant cost industry assumption, and consider the case of increasing cost industry (ICI), in which the firm's cost structure shifts up (i.e., increases) as the industry expands. Likewise, the firm's cost structure shifts down (i.e., decreases) as the industry contracts. Price Individual Firm Industry MC ATC $13 $13 $10 $10 5M 8M 12M 8K 10K Market Quantity, Q (in millions) Representative Firm Quantity, q (in thousands) 1) The increasing cost industry assumption suggests that the expansion of the industry will exert an upward pressure on the prices of inputs [e.g., prices of labor (wage rates), prices of raw materials, and prices of capital (interest rates)] that firms in the industry employ. The ICI assumption is reasonable insofar as the industry in question is _ relative to the size of the whole economy. (Pick: small or large?) Answer: 2) As the industry expands due to entry in the left panel of the diagram, which direction would the firm's ATC and MC curves in the right panel shift (under ICI assumption)? (A) Shift up and to the left. (B) Shift down and to the right. Answer: 3) Given your answer in (2), what is your guess on the extent of supply curve shift due to entry in the left panel? [Pick from: (A) Si will shift pass S2 (i.e., to the right of S2) (B) Si will shift out, but stop before Sz (i.e., to the left of S2), and (C) S1 will shift to Sz.] (Hint: Consider the three facts here: (i) Sz is where S, would shift to under the assumption of constant cost industry, (ii) under the increasing cost industry assumption, the firm's cost structure has increased, and (iii) entry will stop when the price results in zero economic profit.) Answer:4) In the diagram below, we entertain three possible positions to which Si may shift: Point 1, Point 2 and Point 3. Only one answer is plausible, given the increasing cost assumption. (i) Decide which one and draw an industry supply curve passing through that point, and label the new supply curve as "S2 --- ICI" where ICI reminds us that we are entertaining the case of increasing cost industry. (ii) Label the associated new equilibrium price as P* on the price axis in the left panel. Price Industry Individual Firm S1 MC ATC $13 $13 $10 (Q) $10 D1 5M 8M 12M 8K 10K Market Quantity, Q (in millions) Representative Firm Quantity, q (in thousands) 5) Connecting Point ? and the Point you identify in (4), we trace out the industry's long-run supply curve. (i) Label the industry's long-run supply curve as LR Supply Curve. (ii) Is the LR supply curve an upward sloping line or a horizontal line? Answer: What remains to be shown is that we have indeed reached a new long-run equilibrium. Given P*, draw a horizontal price line in the left panel above, and extend it to the right panel above (as we do for other price lines). 6) Given this horizontal price line p*, draw the shifted MC and ATC curves (in small size) in the right panel above that would result in zero economic profit for the representative firm. (Hint: See the example below.) MC new ATC New Representative Fum Quantity With zero economic profit, we confirm that P* is indeed the new long-run equilibrium price. 13 Chapter 7 Exercises | Spring 2023