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John R. Swinton, Ph.D.
Center for Economic Education
Georgia College
& State University

Question:
◦ Suppose that roses are produced in a perfectly
competitive, increasing-cost industry in long-run
equilibrium with identical firms.
 Draw correctly labeled side-by-side graphs for the
rose industry and a typical firm and show each of the
following:
 Industry equilibrium price and quantity, labeled Pm and
Qm, respectively.
 The firm’s equilibrium price and quantity, label Pf and Qf,
repectively.

Assumptions:
◦
◦
◦
◦
◦
◦
Price Takers (buyers AND sellers)
Large Number of Sellers and Buyers
No Barriers to Entry
Identical Products
Complete Information
Profit-maximizing Behavior

Individual Firm Decision:
◦ Rule #1: Set Output such that MC=MR
 MR = Market Price (because the firm is a price taker)
◦ IF MR < min AVC then Shut Down!
◦ IF MR > min AVC but < min ATC then Stay Open in
the short run and Shut Down in the long run
◦ IF MR ≥ Min ATC then Stay Open

Graphically:
Price good X
MC
ATC
Min ATC
0
Quantity good X

Graphically:
Price good X
Supply
MC
ATC
Min ATC
0
Quantity good X
Shut Down
Produce

Meanwhile, the Market:
Price Roses
Supply (or MC)
Pm
Demand (or MB)
0
Qm
Quantity Roses

Meanwhile, the Market:
Price Roses
Supply (or MC)
Pm
Demand (or MB)
0
Qm
Quantity Roses

Graphically:
Price Roses
MC
ATC
Pm=Pf=MR
Min ATC
0
Qf
Quantity Roses

Assume there is an increase in demand for
Roses.
Price Roses
Supply (or MC)
New Pm
Pm
New Demand (or MB)
Demand (or MB)
0
Qm New Qm
Quantity Roses

Short-run reaction:
Price Roses
MC
New Pm=Pf
ATC
Pm=Pf=MR
0
Qf
New Qf
Quantity Roses

Short-run reaction:
Price Roses
MC
New Pm=Pf
ATC
Profits
0
New Qf
Quantity Roses

Long-run:
◦ Profits attract entry of identical firms.
Price Roses
Supply (or MC)
New Pm
Pm
New Demand (or MB)
Entry
0
New
NewLong-run
Qm
Qm Quantity Roses

Long-run reaction:
◦ As firms enter the price returns to its original level
Price Roses
MC
New Pm=Pf
ATC
Original Pm=Pf=MR
0
Original Qf New Qf
Quantity Roses

Results:
◦ Number of firms will increase – because they were
attracted by the profits created by the increase in
demand.
◦ Each firm’s ATC will remain exactly where it was
before – nothing in the question impacts the cost of
production.
◦ Profit maximizing price will be exactly as it was in
the original part – the firms that entered were
exactly the same as the ones that were already in
the industry so their ATC look the same.
◦ Profits will be zero once again.