1. Explain. using a diagram. why a monopolistically competitive industry is not as efficient as a competitive industry even though both firms do not earn an economic profit when their industries are in long-run equilibrium.
For a typically monopolistically competitive firm in the long run, price is higher than marginal cost. The consequence is deadweight loss, represented in the abose diagram by the area of the shaded triangle. This deadweight loss means this industry is not as efficient as a perfectly competitive industry. Howes cr. the increased satiety could at least partially offset this deadweight loss. The 'excess capacity' may ins ols e the use of resources required to differentiate the product.
2. "More than one billion of cups of coffee are consumed in Australia's cafes, restaurants and other outlets each year, an increase of 65 per cent over 10 years. People are drinking less 'Instant coffee' as espresso becomes more popular and new speciality coffee shops have been popping up all over Australia to satisfy demand for daily caffeine fix. Not only are people drinking more coffee, they are becoming more coffee-savvy and want premium brew even if it costs more.'
Answer the following questions after reading the news clip above.
a. How would classify the espresso coffee market; are firms price takers or price makers? Explain.
b. With the aid of an appropriate economic model, explain why there has been such an explosion in the number of coffee chains in Australia over the past 10 years.
c. Do you for see firms in the market making positive economic profit In the long run? Explain.
d. Would the impact of government subsidy to each existing firm change your answer in part (c) In the short run? Explain.
3. Suppose the tea market can be described by the following equations:
Demand: P = 10 - Q
Supply: P = Q -4
where p is the price in dollars and Q is the quantity in kilograms.
a. What is the equilibrium price and quantity?
b. Suppose the government grants a subsidy of $1 per kilogram of tea produced. What will the new equilibrium quantity be? What price will the buyer pay? What amount per kilogram (including the subsidy) will the seller receive? What will be the total cost to government?
4. Suppose a monopolistically competitive industry is in long-run equilibrium. Suppose the government wants this industry to expand and gives each firm a specific amount (a subsidy or negative tax) for each unit produced.
Draw a diagram to explain this situation. What happens to the price, quantity, and number of firms in the industry when long-run equilibrium is reestablished?
Assume a typical firm in this industry is producing at Q, and with price PI wATC, since the industry. is in long-run equilibrium with zero economic profit. The subsidy causes the firm's ATC and NC' turves to fall from AM and AW, to ATM and MC: respectively. Given this new cost structure, the firm will produce Q2 units of output and charge price P2 for it. Al the new output level average cost is less than price and the firm earns an economic profit equal to the area of the shaded rectangle in the above diagram.
The economic profit will attract new firms into the industry, causing the above firm's demand and marginal revenue schedules to shift hack until the demand schedule is tangent to A IC: . When long -run equilibrium is reestablished prices will be lower, output will be higher, and there will be more firms in the industry making zero economic profit as before.