Refer to the figure. Panel (a) shows the Marginal Cost and Average Total Cost fo

Question

Refer to the figure. Panel (a) shows the Marginal Cost and Average Total Cost for a perfectly competitive firm. Panel (b) shows the market demand and the market supply curves. Assume that the market starts in equilibrium at point A in panel (b). Suppose that market demand increases from DO to D1. Which of the following statements is NOT correct? Price Price (b) MC ATC P2 P2 P1 P1 Quantity Quantity Q1 a2 O 1) rising prices and falling profits for existing firms in the market. 2) a new short-run market equilibrium at point B. 3) a new long-run market equilibrium at point C eventually. 4) an eventual increase in the number of firms in the market. Save

Explanation / Answer

Answer
Option 1
The increase in price increases profit in the market because the increased price is above ATC
and Profit=(P-ATC)*Q
P>ATC so the profit is positive
whereas at old equilibrium P=ATC where profit is zero

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The new short-run equilibrium is B because the equilibrium is at market demand equal to supply and the Market demand is D1 and supply is S0
it is at point B
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The long-run market equilibrium in perfect competition is a minimum of average total cost and the cost is minimum at P1 where D1=S1
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The S0 to S1 shifts occur in long run because the firms are making profit and the profit attracts new firms in the market which eventually increases supply and decreases price to P1

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