Question 1

Consider Figure 1 which shows the cost curves of a price taking firm. The market price is given

by P.

a) Write down the profit-maximizing

on Figure 1, the profit-maximizing

condition for a firm. Redraw Figure 1. Clearly label

quantity for this firm and label it as q1.

b) State whether this firm is making a profit or loss when it produces q1. Clearly label on

Figure 1, the profit or loss made by the firm when it produces q1.

c) Consider an industry made up of many firms that are identical to the firm shown in

Figure 1, each of which is producing q1 in the short run. Assume that the standard

assumptions of the perfectly competitive industry model hold. Explain in detail what

happens in this model in the long run. Specifically mention how, going from the short run

to the long run equilibrium, the following change: the output of each firm, the industry

output, the market price, the profit of each firm, the number of firms in the industry and

the industry supply curve. Explain why each of these variables change. Please include the

relevant diagrams for the firm and the industry showing the long run equilibrium.