Question 1

(13 Marks)

Consider the graphs below, which depict a firm in a perfectly competitive market in long run equilibrium. Answer the questions that follow (from a) to h).

Questions 1 a) to h) carry 1 mark each

a)What is the market equilibrium price and quantity?

b)Assume there is an increase in market demand of 600 units at each price. Add this to the above diagram and state the new equilibrium price. (To add a new demand curve, click on the above graph and then click on the 'Insert' tab. Select 'Shapes' and then click on 'Lines'. Click on where the demand curve will be according to the new quantity)

c)What is the new optimal quantity that the firm should produce?

d)What is the firm's new profit?

e)Free entry will allow new firms to enter the market, returning the market to a long run equilibrium. Add this to the above diagram. (To add a new supply curve, click on the above graph and then click on the 'Insert' tab. Select 'Shapes' and then click on 'Lines'. Click on where the supply curve will be according to your knowledge on long run equilibrium)

f)What is the final market equilibrium price and quantity?

g)What is the optimal quantity that the firm should produce and what profit will they now make?

h)How many firms are now in the market?

i)Assume that you have set up a small business in a perfectly competitive industry. Your short-run period is six months, based on the amount of time for which you are locked into a lease agreement for the premises. Consider your financial situation:

Total revenue:$1000 per week

Fixed costs:$800 per week

Variable costs:$700 per week.

Considering these figures,will you keep operating the business in the short run, or will you shut it down and wait for the lease to expire? Explain your answer, illustrating it with a diagram.