Suppose the market demand and supply functions are QD = 220 – 1.6P and QS = 4P – 116. You have just graduated and moved to this city; as a new MBA and an entrepreneur, you are considering entering the market for this product.
Q) You’ve researched and found that most firms in the market currently experience costs such that TC = 30 + 65Q – 14Q2 + 2.4Q3. Determine whether or not you should enter this market.
a. Firms are profitable when P exceeds MC; this only occurs at very low levels of output for my firm and thus I should not enter.
b. Plugging the market equilibrium quantity into this total cost function results in huge costs for my firm, so I should not enter.
c. Where the current equilibrium P = ATC, that price exceeds the marginal cost so I would be profitable upon entering.
d. Using the P=MC rule, the equilibrium price is above ATC at the best quantity, so entering would be profitable.
Q) Due to unforeseen delays, you don’t enter the market. However, a year later the market supply has changed to QS = 4P – 60. Are you surprised at this shift in supply?
a. Yes; the earlier profits should have caused mergers among firms, reducing the number of suppliers and thus supply itself (curve should shift left), though the new supply curve has actually increased (shifted right).
b. No; the profit that was earned under the old supply curve would attract new entrepreneurs, shifting supply to the right (which is what this new supply curve did).
c. No; the losses incurred in the previous question suggest that some firms would exit. This exit would shift supply left, which is what the new supply equation did.
d. Yes; the losses earned earlier should have reduced supply whereas this new equation shows an increase in supply.
Q) Given the new supply conditions (QS = 4P – 60), determine whether or not you should enter the market.
a. Yes; the new equilibrium price is now between AVC and ATC, so firms (including my new one) will choose to stay open.
b. No; the new equilibrium price is below AVC so if I entered I would have to immediately shut down.
c. Yes; even though the new equilibrium price is below ATC, the time lag would allow our firm to continue charging the old (and profitable) equilibrium price during the short run.
d. No; the new equilibrium price is below ATC (though above AVC) at the optimal quantity. If I entered I’d immediately suffer losses.