Sara is a dot.com entrepreneur who has established a Web...

Sara is a dot.com entrepreneur who has established a Web site at which people can design and buy sweatshirts. Sara pays $\$ 1,000$ a week for her Web server and Internet connection. The sweatshirts that her customers design are made to order by another firm, and Sara pays this firm $\$ 20$ a sweatshirt. Sara has no other costs. The table sets out the demand schedule for Sara's sweatshirts. $$\begin{array}{cc} \begin{array}{c} \text { Price } \\ \text { [dollars per sweatshirt/ } \end{array} & \begin{array}{c} \text { Quantity demanded } \\ \text { (sweatshirts per week) } \end{array} \\ \hline 0 & 100 \\ 20 & 80 \\ 40 & 60 \\ 60 & 40 \\ 80 & 20 \\ 100 & 0 \end{array}$$ a. Do you expect other firms to enter the Web sweatshirt business and compete with Sara? b. What happens to the demand for Sara's sweatshirts in the long run? What happens to Sara's economic profit in the long run?

Sara is a dot.com entrepreneur who has established a Web site at which people can design and buy sweatshirts. Sara pays $\$ 1,000$ a week for her Web server and Internet connection. The sweatshirts that her customers design are made to order by another firm, and Sara pays this firm $\$ 20$ a sweatshirt. Sara has no other costs. The table sets out the demand schedule for Sara's sweatshirts.
$$\begin{array}{cc}
\begin{array}{c}
\text { Price } \\
\text { [dollars per sweatshirt/ }
\end{array} & \begin{array}{c}
\text { Quantity demanded } \\
\text { (sweatshirts per week) }
\end{array} \\
\hline 0 & 100 \\
20 & 80 \\
40 & 60 \\
60 & 40 \\
80 & 20 \\
100 & 0
\end{array}$$
a. Do you expect other firms to enter the Web sweatshirt business and compete with Sara?
b. What happens to the demand for Sara's sweatshirts in the long run? What happens to Sara's economic profit in the long run?

Key Concepts

Economic Profit

Economic profit is the difference between total revenue and total costs, including both explicit and implicit costs. In a competitive market, if a firm earns a positive economic profit, it signals that resources are being used in a way that earns more than the opportunity cost, which encourages other firms to enter the market.

Free Entry in Competitive Markets

Free entry refers to the idea that there are no significant barriers for new firms to enter an industry when there are positive economic profits. This influx of new competitors increases supply and competition, which typically drives down prices until firms are only able to earn normal profits in the long run.

Long-Run Equilibrium

Long-run equilibrium in a competitive market is achieved when firms earn zero economic profit. At this point, the market supply is such that the price equals the minimum point of the average total cost curve, meaning that any additional entry would result in losses, and no further profitable opportunities exist.

Demand Curve Facing an Individual Firm in a Competitive Environment

Although the market demand might be downward sloping, an individual firm in a competitive market faces a perfectly elastic demand at the market price in the long run. This is because many firms offer identical products, and consumers will switch providers if one firm tries to raise its price, which means each firm must accept the prevailing market price.

Transcript

00:01 All right.

00:01 In this problem, we have a business owner who is looking to maximize her profit.

00:07 And we know some information about the prices.

00:09 She can sell her product, her sweatshirts for, and the quantities at which she can sell.

00:14 And we know some information about her revenues and costs.

00:17 So how we're going to approach this is go through.

00:20 And for each price and quantity, we're going to find the total revenue, which will be price, time quantity, to see how much money she's bringing in from sales.

00:28 And then we're going to find the total costs, and it's important to note that we have two different types of costs.

00:34 We have a fixed cost of $1 ,000 per week for her web service, and then we have a marginal cost of $20 per sweatshirt being sold.

00:43 So we have to make sure we're multiplying that marginal cost by the quantity, and we're always adding on that fixed cost.

00:50 So here's our equation for costs here, fixed cost plus marginal cost times quantity.

00:55 And then once we have those, we can find our profit, simply by subtracting all of our costs from all of our revenue.

01:02 And that will be our economic weekly profit.

01:05 So i've gotten us started here.

01:07 This first one is a little self -explanatory.

01:10 You're not going to make much of a profit because you're selling at a price of zero.

01:14 But to go through the process, we have that price times quantity for our revenue will be zero.

01:20 And we are still incurring costs because you have that fixed costs of $1 ,000 a week.

01:26 And you still have to pay $20 for each swipe.

01:28 Shirt and our quantity of sweatshirts is 100.

01:31 So 100 plus another 1 ,000 plus 2 ,000.

01:37 Our costs are 3 ,000.

01:39 Zero minus 3 ,000.

01:40 Our profit is negative 3 ,000.

01:43 You probably wouldn't want to operate in this situation.

01:46 So we'll keep going to see if that increases.

01:49 At a price of $20, you can sell 80 sweatshirts, revenue, price times quantity, $1 ,600.

01:56 And our costs, we still have our $1 ,000 fixed cost.

02:00 And this time, um, we're adding on our marginal cost of 20 times 80 is our quantity.

02:06 So 1 ,000 plus 20 times 80 is 2 ,600 as our costs.

02:11 Um, so our revenue 1 ,600 minus our cost, 2 ,600 give us a profit of negative 1 ,000...

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