What do you understand by the term “a highly competitive industry”? Explain what is meant by diminishing returns. From these costs, curves explain when diminishing returns set in? Why?
“A highly competitive industry” is an industry in which there exist numerous numbers of companies in an industry that has extremely low entry barriers (Economics.csusb.edu, 2010).
Low entry barriers imply that each time competition decreases, a number of companies by a huge proportion also reduce while profits increases; meanwhile new companies try to penetrate the industry in order to take advantage of the increasing profits (Economics.csusb.edu, 2010).
Diminishing returns are a reduction in the per-unit quantity of the process of production as the output of an individual production factor is raised, whilst the output of every other production factor remains constant (Discusseconomic.com, 2011). Diminishing returns take root beyond Q=6 when the MC curve begins to increase; ATC continues to drop until Q=8 when the increase in AVC corresponds with a drop in AFC. Quantity Q=8 is the ATC lowest point for the company in the short-run and this is because it is the quantity of productive efficiency.
Explain and illustrate the relationship between ATC, AVC, and AFC.
MC intercepts the ATC and AVC curves at their least points as shown by the graph above; thus, when MC is under ATC, ATC is decreasing, and when MC is over ATC, ATC is increasing. MC increases with the output and MC crosses both AVC and ATC curves from underneath at their least points and proceeds higher. The AVC and ATC curves contract together as quantity rises since the only variation in AVC and ATC are AFC. Because AFC decrease as quantity is extended and the variation between ATC and AVC diminishes, the FCs are allocated to the rising output level (Tutor2u.net, 2011).
Using the firm’s profit maximization graph, explain whether the company will continue to operate in the short and long run at the market price of $ 24.
The firm will continue to operate at the market price of $24 in the short run because it is operating in a competitive environment and a firm’s decision does not impact the price set by the market no matter what quantity the firm produces. But in the long run, the price will be below $24 due to an increase or change in the production factors like improvement in technology which increases supply in the industry and reduces the price at a point where MR=MC (Enterprisestrategygroup.com, 2010).
If this firm is typical of firms in the industry what will be the industry’s long-run price and the firm’s long-run profit position? Explain the process by which the industry and the firm adjust to this long-run position. Will the industry experience an increase or decrease in the number of firms in the long run? Why?
The long-run price will be equal to the MR this is because firms in perfect competition take the price (P=$24) and the firms receive average revenue (AR) in return, which is equal to P. Therefore, AR=P which is stable, and MR for additional units sold which to equate to P, which is similar to AR. As a result, the firm’s long run profit will be equal to zero (Economicshelp.org, 2010).
In the short-run the market price at equilibrium is established by market forces of supply and demand; in this case, the market-clearing price is $24 that is applied by every company in the industry.
Since the price of the market is stable for every unit sold, the AR curve turns out to be the MR; now, a company will only maximize profit when MR=MC. Thus, the firm will sell Q units at $24 and make an economic profit in the short-run since the price of $24 will be higher than ATC. In the long-run, however, the production factor such as technology or labor may change implying the supply curve may shift to a higher level establishing a new equilibrium point that is below the price= of $24. Despite this the MR must equate to MC, meaning that the price has reduced due to increased supply. A price of less than $24 reduces revenue and consequently profit, and a long-run position is established (Economicshelp.org, 2010).
The industry will experience a decrease in the number of companies in the long run as the firms exit the industry as a result of the high cost of production and lack of supernormal profits which attracted them to the industry in the first place (Economicshelp.org, 2010).
A university researcher develops a technological break-through that lowers costs. If fixed costs decrease to $20, determine what happens to the efficient scale? What happens to ABC Company’s profit in the short and long-run? What will be the long-run equilibrium price? Will there be entry or exit of firms in the long run?
In the long run, the price will reduce, therefore an improvement in technology will increase supply in the industry forcing prices to rise. Therefore the efficient scale in the industry will increase since the fixed cost has reduced meaning the firm will produce more at the least point on ATC (Demonstrations.wolfram.com, 2011). In the short run, ABC profit will be supernormal because of the low cost of production and a high price per unit sold, while in the long run, the firm will make normal profit or losses due to an increase in variable cost as the firm produces more and new entrants come into the industry.
The long-run equilibrium price will be below the market price established in part 6 above but at a point where MR=MC. In the long-run firms making economic losses will exit the industry and there will be no entry as costs of doing business will be high (Economicshelp.org, 2010).
A change in government labor policy lowers the wages of workers that ABC Company and similar firms employ. At each output, variable costs decline by $4 while the fixed cost remains at its original level of $ 46. What happens to ABC’s profit in the short run and long run? What happens to the long-run equilibrium price?
The lowering of labor costs will reduce the total costs and variable costs of manufacturing by $4, but fixed costs will not change. In the short run, the firm will make a supernormal profit since the price of each unit will increase and the cost of production will have reduced, while in the long run, the firms will make normal profit or losses due to the decreasing price of the product forcing firms to leave the industry. ABC’s long-run equilibrium price will be below the one established in part 6 (but MR must equate to MC) above due to increased supply in the industry and this will remain constant (Economicshelp.org, 2010).
A government scientist develops a technical breakthrough that lowers costs. If Fixed Costs decrease to $ 26 and the fall in wages causes the variable costs to decline by $ 4 as in Question8, determine what happens to the efficient scale? What happens to ABC’s profit in the short run? In the long run? What happens to the long-run equilibrium price?
In this case, then the efficient scale of the firm will improve as it will be able to produce more at lower costs; this will then increase the market supply. In the short run, ABC profit will be supernormal because of the reduced cost of production as well as an increase in the efficient scale, but this will change in the long run because the price of the unit sold decreases because more firms are attracted to the industry increasing the supply and forcing prices down; this eventually leads to normal profit at the point where MR=MC. In the long-run equilibrium price will be below the one established in part 8 above, this is because of the increased supply plus the new entrants in the industry-leading to a drop in the unit price of products sold (Demonstrations.wolfram.com, 2011).
References
Demonstrations.wolfram.com. 2011. Profit maximization in perfect competition. Web.
Discusseconomic.com. 2011. Microeconomics profits maximization: shutdown point. Web.
Economics.csusb.edu. 2010. Highly Competitive Industries and the Supply Curve. Web.
Economicshelp.org. 2010. Perfect competition. Web.
Enterprisestrategygroup.com. 2010. Efficient scale-out. Web.
Tutor2u.net. 2011. Short run Costs. Web.