Principles of Economics

Running head: PRINCIPLES OF ECONOMICS
PRINCIPLES OF ECONOMICS
Name of the Student
Name of the University
Author Note

1PRINCIPLES OF ECONOMICS
Table of Contents
Answer 1:...................................................................................................................................2
a..............................................................................................................................................2
b..............................................................................................................................................3
Answer 2:...................................................................................................................................4
a..............................................................................................................................................4
b..............................................................................................................................................5
Answer 3:...................................................................................................................................7
a..............................................................................................................................................7
b..............................................................................................................................................7
c..............................................................................................................................................8
d..............................................................................................................................................9
Answer 4:.................................................................................................................................10
a............................................................................................................................................10
b............................................................................................................................................10
References:...............................................................................................................................12

2PRINCIPLES OF ECONOMICS
S
D
D1
Price Price
P
O
Output Output
Market Price taker firm
Q
Answer 1:
a.
In a perfectly competitive market, firms are price taker as none of them can change
the market price. New firms can enter into the market without any restrictions and each of
them sells similar products. Therefore, each firm possesses a very small portion of the entire
market. According to the characteristic of this market, each firm and each consumer has
perfect knowledge of others (Cowell, 2018). If one of them change price then other firms can
also change accordingly in order to earn higher profit. Therefore, market price remains stable
at equilibrium level. The following diagram represents this situation accordingly.
Figure 1: Price taker firm in a perfectly competitive market
The above figure represents the equilibrium condition of a perfectly competitive
industry. The market receives its equilibrium price when demand and supply equate with
each other. At this price, each firm set their demand curve, which is a horizontal straight line.

3PRINCIPLES OF ECONOMICS
AC
E
Market Firm
Price Price
O
Output Output
P1
P0
C
Q2Q1
D
S1
S2
MC
MR0
MR1
b.
In short-run, a perfectly competitive firm incur loss or earn economic profit.
However, this firm earns only normal profits in long-run. This happens as firms can enter or
exit freely. In short run, firms may earn economic profit and this further can attract others to
enter into the market gradually (Currie, Peel & Peters, 2016). On the contrary, firms can incur
loss in short run and this further may lead some existing firms to exit from the market. As a
result, those firms, who earn normal profit, remain into the market.
Figure 2: Short-run and long-run condition of a perfectly competitive firm
The above figure represents both short-run and long-run condition of a perfectly
competitive firm. Initially, the firm makes short-run loss by CP1 amount. In this situation, the
supply curve of the firm is S1. However, the firm tends to decrease its supply to avoid loss.
As a result, the curve shifts leftward from S1 to S2. Therefore, in long-run the firm will earn
normal profit only at P0 price, where marginal cost, average cost and marginal revenue
equate with each other. Some firms may leave the market to avoid such losses. On the