Consider an industry in which firms can expect to sell 1,000 units annually at a market price of P. Before…

| February 9, 2015

Consider an industry in which firms can expect to sell 1,000 units annually at a market price of P. Before firms enter, they do not know their production costs with certainty. Instead, they believe that unit costs can be $2, $4, $6, or $8 with equal probability. Annualized sunk production costs are 1,500 – firms cannot recover this expense should they choose to exit. What is the equilibrium price at which firms are indifferent about entering? What is the average profit of firms that are producing? (Hint: Firms will produce as long as the price equals or exceeds unit production costs.)

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