S. Klepper, Economics 73-100, Fall 2011

Solution to Quiz 6

The increase in the tax will have no effect on the market demand curve, but it will increase the marginal, average variable, and average total cost by $2,000 at every level of output. Consequently, it will increase the minimum average total cost of production by $2,000. If the industry were originally in long-run equilibrium, then the price of automobiles must have equaled the minimum average total cost of production. Since the minimum average total cost of production rises by $2,000, this must cause the price in the long run to rise by $2,000. Given that the market demand curve is unaffected, the increase in the price of $2,000 must cause a decrease in the quantity purchased. For this to come about, some firms must exit the industry. Exit will continue until the price rises by $2,000 and the remaining firms earn zero economic profits.

Based on this description, the answers to the individual questions are:

_____1. True

_____2. False

_____3. True

_____4. True

_____5. True