EC 203 - INTERMEDIATE MICROECONOMICS

Boğaziçi University - Department of Economics

Fall 2019
Problem Set 8 - Solutions

1. Each firm in a competitive market has the same cost function of c(q). The market demand function is
Qd = 24 − p. Determine the long-run equilibrium price, quantity per firm, market quantity and number of
firms when

(a) c(q) = 16 + q 2
Solution: In the long-run equilibrium price p∗ , the profits are zero, that is p∗ = M C(q) = AT C(q).
We have M C(q) = 2q and AT C(q) = 16/q + q. Then MC=ATC implies 2q = 16/q + q, that is, q = 16/q
which implies q ∗ = 4, the long-run equilibrium output per firm.
The long-run equilibrium price is simply M C(q ∗ ) = 2q ∗ = 2 · 4 = 8.
The market quantity is determined through the market demand, Qd (p∗ ) = 24 − p∗ = 24 − 8 = 16.
The number of firms in the long-run n∗ = 16/4 = 4.
(b) c(q) = q − q 2 + q 3
Solution: In the long-run equilibrium price p∗ , the profits are zero, that is p∗ = M C(q) = AT C(q). We
have M C(q) = 1−2q +3q 2 and AT C(q) = 1−q +q 2 . Then M C = AT C implies 1−2q +3q 2 = 1−q +q 2 ,
that is, 2q 2 = q which implies q ∗ = 0.5, the long-run equilibrium output per firm.
The long-run equilibrium price is simply M C(q ∗ ) = 1 − 2q ∗ + 3q ∗ 2 = 1/4 = .75.
The market quantity is determined through the market demand, Qd (p∗ ) = 24 − p∗ = 24 − .75 = 23.25.
The number of firms in the long-run n∗ = 23.25/.5 = 46.5, that is, n∗ = 46.

2. The bolt-making industry currently consists of 20 producers, all of whom operate with the identical short-run
total cost curves c(q) = 10 + q 2 where q is the output of a firm. The market demand for bolts is Qd = 110 − p
and the industry is perfectly competitive.

(a) What is the short-run supply curve of a firm?

Solution: First let’s find the minimum of AVC curve. Find the quantity level that gives M C = AV C,
where M C = 2q and AV C = q 2 /q = q. Then M C(q) = AV C(q), implies 2q = q that is q = 0. Thus,
for any q > 0, MC is above AVC. Thus the short-run supply curve is the entire MC curve: p = M C(q),
that is, p = 2q, or q(p) = p/2 is the short-run supply curve.
(b) What is the short-run market supply curve?
Solution: In the short-run the number of firms is fixed at 20. Thus, the short-run supply curve is the
summation of these 20 firms’ short-run supply curves: Qs (p) = 20(p/2) = 10p.
(c) Determine the short-run equilibrium price and quantity in this industry.
Solution: The short-run equilibrium price is given by the equality of market supply and market
demand. Qd (p) = 110 − p and Qs (p) = 10p, that is, 110 − p = 10p, which implies 11p = 110 and
p∗ = 10. Then, the market equilibrium quantity is Q∗ = 100.

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3. Suppose that in a perfectly competitive market each firm has a long-run supply function c(q) = kq 2 , where
k > 0. Suppose also that the prevailing market price is p > 0. For what values of k and p does this firm exit
the market?
Solution: The decision to exit the market is given by p < AT C(q), that is, p < kq. Note that firm’s
quantity in the long-run is given by M C(q) = p, which is 2kq = p, that is, q = p/2k. Thus, p < AT C(q) can
be written as p < k(p/2k), that is, p < p/2, which is never the case as long as p > 0. Thus, for any values
of k and p, the firm never exits.

4. Suppose that in a perfectly competitive market each firm has a long-run marginal cost given by M C(q) =
100 − 20q + 3q 2 , and a long-run average cost AT C(q) = 100 − 10q + q 2 . The market demand is given by
Qd = 22500 − 100p.

(a) What is the long-run competitive equilibrium price in this market?

Solution: In the long-run, p = M C(q) = AT C(q), which implies 100 − 20q + 3q 2 = 100 − 10q + q 2 ,
that is 2q 2 = 10q, or q = 5. The price is p∗ = M C(5) = 100 − 20 · 5 + 3 · 52 = 75.
(b) How many firms are in this market in a long-run competitive equilibrium?
Solution: The market equilibrium quantity is given by Qd = 22500 − 100 · 75 = 15000. Then the
number of firms will be n∗ = 15000/5 = 3000.

5. An industry has the demand curve Qd (p) = A − p. Each of a very large number of potential firms has the
long-run cost function (
q + q 2 + 9 if q > 0
c(q) =
0 if q = 0

(a) For A = 28, in the long-run competitive equilibrium, find the price, the market output, output per
operating firm, and number of operating firms.
Solution: We know that in the long run price must equal the minimum average total cost of the
individual firm, and

T C(q) 9
AT C(q) = =1+q+
q q

We know that ATC reaches its minimum where it intersects with MC, which is given by

M C(q) = dT C/dq = 1 + 2q

and so we can solve for the value of q ∗ at which the minimum occurs, which is also the output per
operating firm:
9
1 + q∗ + = 1 + 2q ∗ ⇐⇒ q ∗ = 3
q∗
and so the price (minimum average cost) is given by

9
p∗ = AT C(3) = 1 + 3 + =7
3

Finally, we have that the demand function is given by Qd (p) = 28 − p. The market equilibrium output

2
 is given by
Q∗ = Qd (p∗ ) = 28 − p∗ = 28 − 7 = 21

Then, the equilibrium number of firms is given by

n∗ = Q∗ /q ∗ = 21/3 = 7

(b) Now the demand curve shifts up in the sense that A increases to 67. In the short run, the number of
firms is fixed at the number you found in part (a) above. Find the new short-run equilibrium price and
per-firm output.
Solution: The number of firms is fixed at n = 7. From individual firms’ profit maximization we know
that the equilibrium price must equal marginal cost, and so we have that

p∗ = 1 + 2q ∗

where q ∗ is again the individual firm’s optimal output. Equating supply and demand yields

Qs (p∗ ) = Qd (p∗ ) ⇐⇒ 7q ∗ = 67 − p∗

Solving these two together yields

47 22
p∗ = and q∗ =
3 3
(c) Now find the new long-run equilibrium for A = 67.
Solution: We again have, by the exact same reasoning as in part (a), that q ∗ = 3∗ and p∗ = 7. To find
n, we simply equate supply and demand as in part (a), using the new demand curve:

Qs (p∗ ) = Qd (p∗ ) ⇐⇒ n · q ∗ = 67 − p∗
⇐⇒ n · 3 = 67 − 7
⇐⇒ n = 20.

6. The cost function of a typical firm in a competitive industry is given by c (q) = 3q 3 + q, while demand is
given by D (p) = 10 − p.

(a) Suppose there are currently n such firms in the industry. What is the short-run industry supply
function?
Solution: Because n is fixed in the short-run, the industry supply function is given by
n
X
S (p) = qi∗ (p)
i=1
= nq ∗ (p),

where q ∗ (p) is a typical’s individual firm supply function. This is the value of q which maximizes
r (q) − c (q) = pq − 3q 3 + q . The FOC yields

p − 9q 2 − 1 = 0,

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 √
p−1
Note that the second derivative −18q < 0, so the value satisfying the FOC is q = 3 is the solution.
Observe that

V C (q)
AV C (q) =
q
3
3q + q
=
q
2
= 3q + 1
√ 2
p−1
= 3 +1
3
p−1
= +1
3
p+2
= ,
3

and so the firm’s supply function is given by


 q
 if p ≥ AV C (q)
∗
q (p) =

0 if p < AV C (q) ,

√
p−1 p+2


 3 if p ≥ 3
=
p+2

0 if p < 3 ,

√
p−1


 3 if p ≥ 1
=

0 if p < 1,


and so
√
n p−1


 3 if p ≥ 1
∗
S (p) = nq (p) =

0 if p < 1.


(b) What is the long-run industry supply function?

Solution: The long-run industry cost function is determined by profit maximization (p = c0 (q ∗ (p)))
and zero profit (free entry) (p = AT C (q ∗ (p))), and so c0 (q ∗ (p)) = AT C (q ∗ (p)) , which we know only
occurs when

p = pmin ≡ min AT C (q)

 
c (q)
= min
q
 3 
3q + q
= min
q
 2
= min 3q + 1
= 1. (since q ≥ 0 must hold) ,

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 and so the long-run industry supply curve has slope zero (perfectly elastic) and runs through all
quantities at p = 1.
(c) What is the short-run industry equilibrium, (p, q, Q)?
Solution: The three equations characterizing industry equilibrium in the short run are

nq = D (p) (supply = demand)

p= c0 (q) (profit maximization)
Q = nq (market quantity = sum of individual quantities),

which here give us

nq = 10 − p,
p = 9q 2 + 1,
Q = nq.

Substituting the second equation into the first yields

nq = 10 − 9q 2 − 1 ⇐⇒ 9q 2 + nq − 9 = 0
n
⇐⇒ q 2 + q−1=0
√9
n2 + 324 − n
⇐⇒ q = ,
18

which plugged back into the first equation yields

p = 10 − nq
√ 
n n2 + 324 − n
= 10 − ,
18

(which can be confirmed is never less than 1 for any positive n). Finally we have

Q = nq
√ 
n n2 + 324 − n
= .
18

(d) What is the profit of a typical firm in the short-run?

Solution: The profit for a firm in the short-run is given by

r (q) − c (q) = pq − 3q 3 + q = q p − 3q 2 − 1



√
√ √
  !2 
2 n n 2 + 324 − n
n + 324 − n  n2 + 324 − n
= 10 − −3 − 1
18 18 18
1 2p 2 1p 2 1
3 1 3
= n n + 324 − n + n + 324 − n2 + 324 2 − n
216 2 1944 243

This profit approaches to zero as n goes to infinity.

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 (e) What is the long-run industry equilibrium, (p, q, Q, n)?
Solution: The four equations characterizing industry equilibrium in the short run are

nq = D (p) (supply = demand)

p= c0 (q) (profit maximization)
Q = nq (market quantity = sum of individual quantities),
p = AT C (q) (zero profit)

can be solved to yield

p = pmin
q = q min
Q = D pmin ,

D pmin


n =
q min

where q min is defined as the output level which satisfies the condition pmin = AT C q min . Because

AT C (q) = 3q 2 + 1, we have that pmin = 1 and q min = 0, and so the long-run industry equilibrium is

p = 1,
q = 0,
Q = 9,
n = ∞.

That is, it will take an infinite(!) number of firms to drive profits down to zero, and when there are an
infinite number of firms they will each produce “zero”. The total quantity produced will be equal to
Q = 9 in order to meet the demand at price p = 1, but because these 9 units are divided by infinity,
the amount per firm becomes zero.

7. Suppose a monopoly’s inverse demand curve is p = 13 − Q and its cost function is C(Q) = 25 + Q + Q2 /2.
What is the profit maximizing quantity and price if there is no price discrimination? What is the maximum
profit? Should the monopoly operate or shut-down?
Solution: Profit is given by Π = p(Q) · Q − [25 + Q + Q2 /2] = (13 − Q)Q − 25 − Q − Q2 /2 = 13Q − Q2 − 25 −
Q−Q2 /2 = 12Q−3Q2 /2−25. The profit maximizing quantity satisfies the first order condition: dπ/dQ = 0,
that is, 0 = 12 − 3Q, that is, Qm = 4. Then the monopoly price is given by pm = 13 − Qm = 13 − 4 = 9.
The profit is then Π = 12Q − 3Q2 /2 − 25 = 12 · 4 − 342 /2 = 48 − 24 − 25 = −1
Shutting down means producing 0 and paying the fixed cost, that is Πsd = −25.
Thus, the monopoly does not shut down.

8. Suppose that a monopoly faces a market demand given by p = 30 − 2Q. Its total cost is C(Q) = 5 + Q2 .
Suppose the monopoly sets a uniform price. Show that the monopoly operates on the elastic portion of the
demand curve. What is the profit level?

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 Solution: The profit is Π(Q) = p(Q)Q − 5 − Q2 = (30 − 2Q)Q − 5 − Q2 . Then, the first order condition
is Π(Q) = 30 − 6Q = 0 which implies QM = 5, pM = 20. At these quantity and price levels, the elasticity
is given by  = |(dQ/dp)(p/Q) = −(−1/2)(20/5)| = 2 > 1, thus it is on the elastic portion of the demand
curve. The profit is ΠM = 70.

9. A monopoly has cost function C(Q) = 6Q. The output Q is consumed only by consumer a and consumer b.
Consumer a has the demand function Qa (p) = 10 − p, and that of consumer b is Qb (p) = 20 − p.

(a) Find the industry demand function Q(p); the inverse demand function p(Q); the revenue function R(Q);
and the marginal revenue function M R(Q).
Solution We find industry demand by simply adding the individual demand curves, so


 Qa (p) + Qb (p) if p ≤ 10





Q(p) = Qb (p) if 10 < p ≤ 20






0 if p > 20



 30 − 2p if p ≤ 10





= 20 − p if 10 < p ≤ 20






0 if p > 20.


The inverse demand is then given by



 20 − Q if Q ≤ 10





30−Q
p(Q) = 2 if 10 < Q ≤ 30






0 if Q > 30.


The revenue function is

R(Q) = Q p(Q)
= Q p(Q)


 20Q − Q2 if Q ≤ 10





30Q−Q2
= 2 if 10 < Q ≤ 30






0 if Q > 30,


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 and so marginal revenue is


 20 − 2Q if Q ≤ 10





M R(Q) = 15 − Q if 10 < Q ≤ 30






0 if Q > 30.


(b) Find the monopoly output QM and price pM .

Solution By equating marginal revenue with marginal cost we get

M R(Q) = M C(Q) = 6

Note that for 10 < Q ≤ 30, this means 15 − Q = 6 ⇐⇒ Q = 9, but this contradicts 10 < Q ≤ 30 and
so we have the solution for when Q ≤ 10, which is

20 − 2QM = 6 ⇐⇒ QM = 7.

The price is then simply given by

pM = p(QM )
= 20 − 7
= 13.