# 2005 AP Microeconomics Question 1.

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2005 AP Microeconomics Question 1

Bestmilk, a typical profit-maximizing dairy
firm, is operating in a constant-cost, perfectly competitive industry in long-run equilibrium.

Draw correctly labeled side-by-side graphs for
LRATC MC p P MR=D=AR=P D q Q Q Q Bestmilk Firm Market/Industry Draw correctly labeled side-by-side graphs for the dairy market and for Bestmilk and show each of the following. (i) Price and output for the industry (ii) Price and output for Bestmilk

P Q S D p q Bestmilk Firm Market/Industry P1 D1 Q1
LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry P1 D1 Q1 (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (i) Price and output for the industry

P Q S D p q Bestmilk Firm Market/Industry P and Q go down. P1 p1 D1 Q1
LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 p1 MR1=D1=AR1 =P1 q1 (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (ii) Price and output for Bestmilk P and Q go down.

P Q S D p q Bestmilk Firm Market/Industry Area of loss: p1p2AB P1 p1
LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 p1 MR1=D1=AR1 =P1 q1 p2 A B Area of loss: p1p2AB (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (iii) Area of loss or profit for Bestmilk

Anytime a question asks whether or not a firm
P Q S D p LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 MR1=D1=AR1 =P1 q1 AVC (c ) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run? Anytime a question asks whether or not a firm should produce, the student MUST draw an AVC curve for the firm.

If the price (Point B) is greater then the
Q S D p LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 MR1=D1=AR1 =P1 AVC B C q1 (c ) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run? If the price (Point B) is greater then the AVC (Point C) at the profit-maximizing quantity, Bestmilk should continue to produce.

(d) Assume that the industry adjusts to a new
P Q S D p LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 MR1=D1=AR1 =P1 AVC S1 q1 (d) Assume that the industry adjusts to a new long-run equilibrium. Compare the following between initial and the new long-run equilibrium. Because economic profits are less than zero, firms will exit the market. (i) Price in the industry

(ii) Output of a typical firm
Q S D p LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 MR1=D1=AR1 =P1 AVC S1 q1 (ii) Output of a typical firm Since Bestmilk firm is a price taker and will take the market price, the firm quantity returns back to the original “q.”

(iii) The number of firms in the dairy industry.
P Q S D p LRATC MC q MR=D=AR=P Bestmilk Firm Market/Industry D1 Q1 P1 MR1=D1=AR1 =P1 AVC S1 q1 Q2 (iii) The number of firms in the dairy industry. Looking at the market graph, as the number of firms exit the industry, quantity goes down.