Assume we have a perfectly competitive industry facing constant costs which have reached a long-run equilibrium at price P∗.
a) What is the long-run equilibrium condition making the firm’s economic profit equal zero?
b) Draw the diagram for the long-run equilibrium market price P∗and quantity produced q∗ for one representative firm in this industry and label it “Figure 1 – Firm”. Include the following cost curves: short-run Average Total Cost (ATC), long-run Average Costs (AC), and short-run Marginal Cost (MC).
c) Draw the diagram for the long-run equilibrium price P∗ and quantity Q∗ for the industry and label it “Figure 2 – Industry”. Include the industry short-run supply and demand along with the industry long-run supply.
d) Assume there is a reduction in consumer’s disposable income in the economy. How will this effect the industry demand curve? Indicate the effect of the demand shift on the price and quantity on both figures 1 and 2.
