Question 7

Consider an individual firm competing in a market with many other producers. Assume this firm faces a conventional production technology. The short-run production function has a small range of increasing marginal product (increasing marginal returns) and then is subject to the Law of Diminishing Marginal Product (diminishing marginal returns).

• Putting quantity q on the horizontal axis and dollars $ on the vertical axis, depict four important curves: Average Fixed Cost (AFC), Average Variable Costs (AVC), Average Total Costs (ATC), and Marginal Cost (MC).
• For this question, assume the individual producers in this industry have no control over prices; they must accept the exogenously given price, P₀.On a graph containing the four curves MC, AFC, AVC, and ATC, depict the profit-maximizing output for this firm under the assumption that the exogenously given price of P₀ is sufficiently high to allow the producer to arrive at an optimal output, q₀, that results in positive profits.
• Graphically indicate the size of the profits for this firm at the exogenously determined price of P₀.
• Finally, consider a new shock to the market. This new shock has pushed prices down to a new level, P₁. Again, the firm cannot change this market-determined price.
• Graphically show this new profit-maximizing output q₁ for this firm given that (a) it has negative profits in this outcome and (b) it does not choose to shut down. Show and label all relevant curves, price P₁, and the new equilibrium output q₁.

Question 8

Refer to the scenario in Question 7 to answer these narrative questions.

(a) Please explain the process you used to determine the optimal output q₀.

(b) Explain the decision to keep producing in the face of negative profits after the shift from P₀ to P₁.

(c) Finally, now suppose that the firm is subjected to a new Licensing Fee that raises its fixed cost of operation significantly but has no impact on the other costs. What should the firm's response be considering it is still in the short run? (No graph needed). Explain.

Question 9

In the first few weeks of our course, we learned that it is not unusual for governments to make direct interventions in markets with the intent of controlling prices. Consider the rental housing market, a frequent target of government price controls.

• Draw a graph that shows supply and demand for rental housing in some community.
• When drawing this graph, please assume that the demand curve is downward sloping and supply curve is upward sloping.
• Clearly show the original market equilibrium prior to any government intervention.
• Please remember to clearly label your axes, with P on the vertical axis and Q on the horizontal axis.
• Label the supply curve as S₀; demand curve as D₀; the equilibrium price as P₀; and equilibrium quantity as Q₀.
• The local government body is extremely concerned about lack of affordable housing in the community, especially in rental housing. To counter this problem, the government decides to put a binding price ceiling, P₁, on this market. Graphically depict such a binding price ceiling.Graphically indicate the quantity demanded by renters (Q_R) and the quantity supplied by landlords (Q_L) at the price ceiling; and indicate what the distance between these two quantities represents.

Question 10

Refer to the scenario in Question 9 to answer these narrative questions.

(a) Will more or fewer apartments be rented once the price ceiling has been imposed? Why?

(b) Is this a successful way to attack the lack of affordable housing? Please explain your response.

(c) Who will benefit and who may be hurt by this price ceiling in the short run and in the long run? Please explain your response