UMGC Landstuhl, Rota + Economics 203 Fall 2020 Exercise

UMGC – Landstuhl y Rota+ Economics 203 Fall (ii) 2020 Exercise Set 5

Analyze the provided market and cost scenarios concerning competitive markets, production decisions, and industry dynamics. This assignment requires calculating missing economic values, interpreting changes in market equilibrium, and assessing firm profitability under different conditions. You are to consider scenarios involving Italian and Spanish food products, asparagus farming, T-shirt manufacturing, and a hypothetical case of market change affecting a specialty product like jamón serrano ham. Use sound economic principles, relevant formulas, and graphs to support your answers.

Paper For Above instruction

In a perfectly competitive market, firms are price takers and produce at levels where marginal cost (MC) equals market price (P), maximizing profits or minimizing losses. The first scenario involves an Italian manufacturer producing lampade da tavola (table lamps). By filling in missing values such as total costs, average costs (AFC, AVC, ATC), and marginal costs, and analyzing the impact of different market prices, we assess the firm's profitability and production decisions.

Scenario 1: Italian Lamp Manufacturer

Assuming the equilibrium market price is $60 per lamp, the firm will produce at the quantity where P = MC. In a perfectly competitive market, this enables the firm to determine its optimal output. Using the marginal cost data, the firm will decide whether to expand or restrict production based on whether the market price exceeds the minimum of its average total cost (ATC).

If the market price is $60, and the firm's ATC at the profit-maximizing output is less than $60, the firm earns positive economic profit. The profit is calculated as (Price - ATC) multiplied by quantity. Conversely, if the price equals the minimum ATC, the firm earns zero economic profit in the long run, typical of perfect competition.

If the market price decreases to $30, and the firm's ATC at the relevant output exceeds $30, the firm faces losses and must decide whether to shut down in the short run. The shutdown decision depends on whether the price covers average variable costs (AVC); if it does, the firm continues operating; if not, it should cease production temporarily.

Scenario 2: Spargel (Asparagus) Farming

Considering a farmer growing Spargel, selling per box at €6, with cost curves provided, the farmer's optimal output level is where price equals marginal cost (P=MC). This calculation enables determining the profit or loss at the chosen output, based on total revenue minus total costs.

If the farmer earns profits at the current price, additional competitors might enter the market in the future, increasing supply and potentially lowering prices. If profits are negative, firms will exit, reducing supply until remaining firms break even, leading to market equilibrium adjustments.

Market dynamics suggest that increased competition tends to push the price toward the minimum average total cost in the long run, ensuring only efficient producers survive. Long-run equilibrium prices are those where P = ATC, with each firm producing at the minimum of their ATC curve.

Scenario 3: Cost Analysis for a Firm with Fixed Costs

Given fixed costs of $350 and varying total costs at different output levels, the analysis involves calculating AVC and ATC at these levels. The fixed costs are simply the costs that do not vary with output (cost at q=0), while variable costs change with q.

The firm would produce profitably if the market price exceeds ATC at its profit-maximizing output. If the price is below ATC but above AVC, the firm may continue operating in the short run, covering variable costs and contributing toward fixed costs, but would eventually exit if prices fall below AVC.

Long-run production decisions depend on whether the market price sustains the minimum of the long-run average cost curve. If the price exceeds this level, firms will enter the market, increasing supply until the price stabilizes at the minimum long-run average cost, leading to normal profits.

Scenario 4: Spanish Cured Ham Market Changes

The market for Spanish jamón serrano is initially in equilibrium with firms producing at minimum long-run average costs, given constant industry costs. A shift in consumer preferences toward Spanish ham will increase demand, shifting the demand curve outward.

This change will lead to a higher equilibrium price and quantity in the market. In the typical firm diagram, firms will increase output to meet the higher demand, potentially earning short-term profits if the new equilibrium price exceeds their average total cost.

If firms experience profits, new entrants will be attracted, increasing industry supply over time, which ultimately pushes the market back to a new equilibrium where firms earn normal profit, and prices stabilize at minimum long-run average costs.

In an increasing-cost industry, as industry output expands, input prices would rise, causing the long-run minimum average cost to shift upward, meaning that the final equilibrium price would be higher, and producers would supply less at each price point than in a constant-cost scenario.

Scenario 5: T-Shirt Market in Sicily

Given the total cost function TC = 500 + 0.1q², the fixed costs are $500 (cost at q=0). The average total cost (ATC) is calculated as (500 + 0.1q²)/q, which simplifies to 500 / q + 0.1q.

Setting P = MC (where P = $20), and knowing MC = 0.2q, the profit-maximizing output is found by solving 20 = 0.2q, giving q = 100 T-shirts.

At q=100, the average total cost (ATC) is 500 / 100 + 0.1 x 100 = 5 + 10 = $15 per T-shirt. Since the market price of $20 exceeds ATC at this quantity, the firm is making an economic profit, leading to potential entry and market expansion until profits are zero in the long run.

The firm will continue operation because the market price surpasses the short-run average total cost, and the profit is positive. This incentivizes new entrants, increasing supply and pushing prices downward until profits normalize at the minimum long-run average cost level, which equals the current market price if industry entry is open and costs are stable.

Summary

Across these scenarios, the core themes involve understanding how firms optimize outputs in perfectly competitive settings, the impact of market shifts on equilibrium prices and quantities, and the importance of cost structures—fixed and variable—in determining profitability and market entry or exit. Properly interpreting these models allows predicting industry responses to changing consumer preferences, cost environments, and competitive pressures, enabling informed strategic decisions for producers and policymakers alike.

References

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