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TAYLORS UNIVERSITY MASTER OF FINANCE/MANAGEMENT PROGRAMME Managerial Economics Tutorial Exercise 6: Firms in competitive markets

KEY CONCEPTS: Perfectly competitive model Economic profit Total revenue Average revenue Marginal revenue ATC, AVC, TC Profit maximisation rule Shutdown and exit decisions Long run equilibrium Task 1 The following represents a total cost schedule for a clothing firm that produces T-shirts. Quantity 0 1 2 3 4 5 6 Total Cost ($) 10 13 15 16 20 30 42

a) Calculate and graph the firms marginal cost, average variable cost and average total cost. b) Assume that the firm operates in a competitive market. If the market price of T-shirts is $10, what is the firms profit maximizing output and is it earning an economic profit? Identify the firms profit and output on your graph. c) At what market price will the firm break-even (earn zero economic profits)? d) At what market price will the firm consider temporarily shutting down its operations? Explain.

Task 2 PART A Wholesalers of roses (the firms that supply flower shops with roses for Valentines Day) sell roses in containers that hold 120 stems. In Australia, wholesalers operate in a perfectly competitive market. The table below is a cost schedule for one wholesaler Valentine Roses Co.: Quantity Total cost [$] [containers per week] 0 30 1 40 2 52 3 66 4 82 5 100 6 120 7 142 8 166 a) Suppose the market price of roses is $15 per container. What is the profit-maximising quantity Valentine Roses Co will sell and what profit will it earn? Explain your answer. b) Draw the short run supply curve for Valentine Roses Co. Explain how you derived the supply curve. PART B Now assume that the cost schedule for Valentine Roses Co. as shown in Part A above is the one that the firm uses in the long run. a) In long run equilibrium, what would be the price per container of roses and what quantity of containers of roses will Valentine Roses Co sell? Explain how you arrived at this result. b) Suppose all other firms in the wholesale rose industry are identical to Valentine Roses Co. In long run equilibrium, how many firms will operate in the industry? The market demand for roses is: Price per container ($) 14 Market demand 280 [containers per week] 16 240 18 200 20 160 22 120

Task 3 Two Chinese noodle takeaways, Ngs Noodles and Chens Cookhouse, both sell an identical noodle soup and are located in different areas of the city. But the price of noodle soup at Ngs is $5.50, and the price of noodle soup at Chens is $5. Dan says: It is easy to explain this price difference. It must be occurring because there are no other noodle takeaways nearby to Ngs, whereas Chen has several competing noodle takeaways nearby. But Sue disagrees. She says: The reason for the price difference must be that Ngs is located in an area where the population has higher average income than in the area where Chens takeaway is located. Is Dan correct or is Sue correct? Explain your reasoning.