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## Economics Assignment Question

### Problem 1. Markets: Perfect Competition.

Assume that a perfectly competitive, constant cost industry is in a long run equilibrium with 20 firms.

Each firm is producing 150 units of output which it sells at the price of $20 per unit; out of this amount each firm is paying $4 tax per unit of the output. The government decides to abolish the tax.

**a)** Explain what would happen in the short run to the equilibrium price and industry output; number of firms in the industry; output and profit of each firm. Illustrate on diagrams for the market and a particular firm.

**b)** Explain what would happen in the long run to the equilibrium price and industry output; number of firms in the industry; output and profit of each firm. Illustrate on diagrams for the market and a particular firm. Compare both to the initial long run equilibrium and to the short run equilibrium.

### Problem 2. General equilibrium: Efficiency in the Edgeworth box.

Xiao Ping and James always eats miso soup and sushi in exact proportions – one miso per two sushi. They throw away any extra soup or sushi as it would not give them any pleasure. Once, they were stuck in the office together for hours, marking students' assignments. Xiao Ping had 2 miso soups and 10 sushi with him; James had 4 miso and 4 sushi. (For the purpose of this question, assume that miso and sushi can be divided into little pieces so one-half miso or one-hundredth of sushi makes sense)

**a)** Draw the Edgeworth box for Xiao Ping and James. Please put Xiao Ping at the origin and James 'upside down'; put sushi on the horizontal axis and miso on vertical. Show their endowment point.

**b)** Show all Pareto optimal allocations of miso and sushi between Xiao Ping and James in the Edgeworth Box. Please note that this question is a bit tricky, though not difficult. Draw a bunch of indifference curves and look for tangencies.

## Economics Assignment Solution on Intermediate Microeconomics Assignment

### Problem 1. Markets: Perfect Competition

It is given that industry comprising of 20 firms has constant costs and is in long run **equilibrium under perfect competition**. Each firm is producing 150 units of output, which it sells at the price of $20 per unit; out of this amount each firm is paying $4 tax per unit of the output. The government decides to abolish the tax.

a) Initially, the firms received $16 ($20-$4) for each unit of output and there was zero profit in the **long run equilibrium**. The **market price** for each unit was P= MC1 + tax = 16 + 4 = $20. As the tax is abolished, the price received by each firm for one unit of output becomes $20 which is now equal to the market price. The MC and AC of an individual firm shift vertically upwards while the amount of output remains constant at 150 units. Hence, in the short run, the firms start earning a profit ($4 X 150= $600) due to the rise in price. This positive profit poses as an incentive to other firms to join this industry and the number of firms starts increasing gradually in the short run.

The above diagram (Fig.1) shows the **equilibrium price** ($20) and output (150) for a particular firm. The firm's supply curve is given by the MC lying above the AC. Here, the total amount of profit accrued by the firm is equal to the rectangular area enclosed by ABCD.

The following diagram (Fig.2) shows the equilibrium price and **output in case of the whole market**. Here, the industry has 20 firms and the industrial output is 20 x 150 = 3000 units at equilibrium price $20. As new firms enter the market, the total supply in the industry increases and the **short run supply curve** of the constant cost industry shifts to the right. Firms keep entering the market until the profit falls and there is no more incentive for a firm to enter. This gives way to the long run equilibrium condition…

*Read more in the complete solution PDF document at the end of this page.*

### Problem2. General equilibrium: Efficiency in the Edgeworth box

Xiao Ping and James always eats miso soup and sushi in exact proportions – one miso per two sushi. They throw away any extra soup or sushi as it would not give them any pleasure. Once, they were stuck in the office together for hours, **marking students' assignments**. Xiao Ping had 2 miso soups and 10 sushi with him; James had 4 miso and 4 sushi.

a) The Edgeworth box for Xiao Ping and James with their initial endowment points is given below (Fig.5):

Here, OX is the origin for Xiao Ping and OJ is the origin of James. Point A in the diagram shows Xiao's and James' initial endowment point which is given by the coordinates (10, 2) for Xiao Ping and (4, 4) for James.

b) An Edgeworth box is a diagram showing all possible allocations of two goods between two people (Pindyck & Rubinfeld 2004). Efficient allocations can be made in an **Edgeworth box** through trading between Xiao Ping and James. By exchanging some amount of Miso and Sushi between themselves, they can be better off with increased satisfaction levels. As both of them consume the two items at the exact same proportions, they have L-shaped indifference curves with the most efficient bundle lying at the kinks for each IC. James and Xiao are indifferent to any consumption bundle along a particular IC. In this case, both the consumers would be better off if James give away 1 or 2 miso soup to Xiao or Xiao gives away anything between 2 to 6 sushi to James, or both of these exchanges take place together…

(Some parts of the solution has been blurred due to privacy protection policy)

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