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Handmade bicycle frames are produced by a number of identically sized firms. Total (long-run) monthly costs for a typical firm are given bywhereq is the number of frames produced per month. Demand for handmade bicycle frames is given bywhere Q D is the quantity demanded per month and P is the price per frame. To determine the long-run equilibrium in this market, we must find the low point of the typical firms average cost curve. Sincewhich has a convenient solution of q = 20. With a monthly output of 20 frames, each producer has a long-run average and marginal cost of $500. This, then, is the long-run equilibrium price of bicycle frames (handmade frames cost a bundle, as any cyclist can attest). With P = $500, Equation 12.43 shows QD= 1,000. The equilibrium number of firms is therefore 50. When each of these 50 firms produces 20 frames per month, supply will precisely balance what is demanded at a price of $500. If demand in this problem were to increase tothen we would expect long-run output and the number of frames to increase. Assuming that entry into the frame market is free and that such entry does not alter costs for the typical bicycle maker, the long-run equilibrium price will remain at $500 and a total of 1,500 frames per month will be demanded. That will require 75 frame makers, so 25 new firms will enter the market in response to the increase in demand.
Ans: The analysis of the above situation relates to the perfect competition case where initially with the matching of the demand and supply conditions for the bicycles, the optimum market equilibrium is found and the optimal number of firms required in the market are found. This pertains to the case when the optimal output is 20 units and each firm has a marginal cost of $500. The perfect competition equilibrium condition states that P=MC= 500 and the quantity demanded in such case will be 1000 units. This requires the operation of 50 firms. However, when the demand increases, we find that…

hat the long run output and the quantity demanded would increase keeping the long run to be the same. Therefore, there will be a higher quantity of units demanded and because the prices have remained the same, there will be a higher profits of the existing firms which would attract more firms to enter the market and join the production. Therefore the number of firms operating here would increase.

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