ECO 555
Final Exam
Perfect Competition (45 points)
(27 points) A perfectly competitive firm has the short-run marginal cost function,
MC = 3 + 6Q + 3Q2
Where K (capital) is fixed and L (labor)is variable. PK (price of capital) = $3 and P (price of output) = $48
What is the profit maximizing level of Output? Show your work.
Write the equation for Total Costs (TC).
What is TC when profit is maximized?
What is Total Revenue when profit is maximized?
What is Total Profit when profit is maximized?
Approximately, what is Q when ATC is minimized?
Will firms enter or exit in the long-run? (explain your answer)
(6 points) Graph the P, MC, MR, AR and ATC curves in P/Q space to correspond to your answers above. Make sure to label the values (with the numbers you have calculated above) for optimal Q and where the curves intersect optimal Q and where the curves intersect the vertical axis. Make sure to indicate/label profit/loss.
(4 points) Describe the mechanism that adjusts the market to its long-run equilibrium.
(4 points) Describe how a demand shock in a long-run constant cost industry results in a market long-run supply function that is horizontal.
(6 points) In a perfectly competitive market, economic profit for each firm is supposed to be zero in the long-run. There are some industries in which positive economic profits seem necessary in order for these firms to survive in the long run (e.g., banking and pharmaceuticals – assume theses are perfectly competitive, even though they are not). What makes these industries special? Use one of them as a specific example. Should this economic profit be considered part of the cost curves? Give a reason for doing this. If this profit is subsumed into the cost curves, would economic profit be zero in the long run?
(4 points) Explain why a perfectly competitive market is socially desirable.
Monopoly (32 points)
(24 points) A monopolistic firm has the short-run marginal cost function,
MC = 20 + 4Q
Where K…