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Problemset 2
May, 11 2010
This problem set is designed to give you the opportunity to review rm behavior in
all
perfect and imperfect competition frameworks. You are asked to solve exercises
listed below. Be prepared to present your solutions in class either on the blackboard
or the overhead projector.
We encourage you to team up to groups. However, in order to obtain points in
class, you musthand in your solution individually and be prepared to
present it and defend it on your own . Please hand in your solution with our
Monday May 10, 2010
secretary (Schloss, Museumsügel, 019) no later than
11 a.m. . Please do not forget to note your name and matriculation number on
your solution sketch.
Jehle, Georey A., and Philip J. Reny (2000). Advanced Microeconomic Theory.
Addison Wesley, Chapter 4.
Exercise 1: Short-run Equilibrium
Consider a competitive industry composed of J identical rms. Firms produce
output according to the Cobb-Douglas technology, q = xα k1−α , where x is some
variable input such as labor, k is some input such as plant size, which is xed
in the short run, and 0 < α < 1. Let wx and wk denote the price of labor and
capital, respectively. p is the price of the nal good. Suppose α = 1/2, wx = 2,
and wk = 1/2, and k = 1. Market demand is given by q d = 240/p.
1. Set up the cost function and the short-run prot maximization problem of
the rm.
2. Show that the rm's short-run maximum prots are
α
(1)
1 α
π j = p 1−α wxα−1 α 1−α (1 − α)k − wk k.
MSc IBE - SS2010
Jung & Gröschl
3. Derive an expression for output supply per rm in the short-run equilibrium
as a function of the nal good price p.
4. What will the short-run market supply function with J = 60 rms be?
5. Solve for the short-run equilibrium price p, market quantity q , output per
rm q j , and rm prots π j .
6. Illustrate the short-run equilibrium at the market level in a price - quantity
gure. Explain.
7. Use the cost function to derive expressions for short-run marginal costs and
the short-run average costs as a function of q . Depict the short-run marginal
cost curve and the short-run average cost curve in a price - quantity gure.
Use the gure to show whether a rm makes negative, zero, or positive
prots.
C 1 (q 1 ) = c1 q 1 , C 2 (q 2 ) = c2 q 2 , and 0 ≤ c1 ≤ c2 (2)