Suppose a firm's long run marginal cost and long run average cost curves are as shown on the following graph.
a. Suppose the perfectly competitive market price for the firm's good is !∗ = 4. Is the firm's profit positive or negative?
b. Assuming free entry and exit, what happens over time? (Hint: Think about what incentives this creates for other entrepreneurs & investors.) What does this do to the market supply curve? How does this change?
c. Suppose the perfectly competitive market price for the firm's good is !∗ = 1.75. Is the firm's profit positive or negative?
d. Assuming free entry and exit, what happens over time? What does this do to the market supply curve? How does this change?
e. Assuming all firms have this identical production function, what value does approach in the long run? What will the firm's profit be?
f. Does this imply there is no incentive to innovate? What happens to the average cost curve of a firm that invests to develop some new production process? What happens to its profits? What do other firms do in the long run?