Question 1 (9 marks)

Suppose that, in the market for soft drinks (in litres):

demand is given by P = 30 - 0.3Q; and

supply is given by P = 0.1Q.

(a) Explain why the equilibrium price and quantity is Pareto efficient. As part of your explanation, you must explain what Pareto efficiency is and show that it fits this definition.

(b) Assuming that it is a perfectly competitive market, in the long run what would be the price of a product? Explain.

(c) Assume that it is a perfectly competitive market. Explain why the long run the demand curve faced by the firm is horizontal.

(d) In the long run, how is the long-run supply curve derived? What is the shape of the supply curve and what does it represent? i.e. Is it upward sloping/downward sloping/horizontal/vertical/all of the aforementioned? Explain. In your answer, you must explain the assumptions which drive the shape of the curve and what would happen if these assumptions are violated.