Microeconomic Questions - Essay Example

How would, therefore, their profits differ from each other? 11 Is the elasticity of demand useful in terms of predicting the new equilibrium price and quantity in a market following a shock to the supply curve? When there is an increase or a decrease in the supply, the effect on the market is dependent on the elasticity of demand. The more inelastic is the demand curve, the less amount of quantity is sold as well as the price changes keeping all other things equal. When the demand curve is more elastic, the more changes in quantity bring fewer changes in price in a situation of ceteris Paribas.

The magnitude of the effect of the supply side shock is not independent of price elasticity. In a situation of inelastic demand firms have the ability to raise prices as they will have to suffer from only a small drop in demand conditions. The responds of the producers as well as the consumers can affect the supply side shocks. The supply of fast food is elastic. The lesson from the elasticity concepts is more elastic is the curve, the more quantity changes and the more inelastic is the curve the more price changes.

The elasticity is not only useful in order to predict the events of the markets but also to analyze the policies of the government. If a new subdivision is built near the shopping complex of a fast food company, the price of hamburger is not rise as much as the sales mainly because the fast food company is too small to generate such a demand that have the potential to increase the price. The elasticity of demand is of course useful in predicting the new equilibrium price as well as quantity because the shift or the trend of the demand curve because of the shock can be judged by the value of the elasticity.

Under perfect competition, describe the long and short run outcomes if a demand curve were to shift to the left. A large number of small firms comprise the market for perfect competition. Each firm is small compared to the entire market. The comprising firms set the identical products. The customers as well as the firms are well informed about the prices. There are no barriers to entry for other firms to enter into the market. In the short run the firms can change only the variable factor namely labor.

The other decisions are predetermined. In the long run the firms have the potential to change their scale. In the short run when the existing price is less than the average cost curve it is better for the firm to close down. When the price is above the minimum point of average total cost, the firm makes profits. In the long run when a certain firm makes profits, new firms enter into the market. In the long run unlike monopoly or oligopoly it is not possible for a firm in perfect competition to earn economic profits.

In a situation of perfect competition, the firm will be able to earn only normal profits and the demand curve will touch the total average cots curve at the minimum point. The firm must decide whether to continue with the business in the long run and cover up the expenses. The decisions in the long run are based on the dependence between the price and the average cost curve in the long run. If the price is greater than or equal to average cots, the firm will continue to operate and close down otherwise.

The above diagram represents a situation under perfect competition. In this case there is leftward shift of the market demand curve due to some reasons. The initial equilibrium price