Question

The accompanying table presents prices for washing and ironing a man's shirt taken from a survey of California dry cleaners. $$ \begin{array}{l|lc} \text { Dry Cleaner } & \text { City } & \text { Price } \\ \hline \text { A-1 Cleaners } & \text { Santa Barbara } & \$ 1.50 \\ \text { Regal Cleaners } & \text { Santa Barbara } & 1.95 \\ \text { St. Paul Cleaners } & \text { Santa Barbara } & 1.95 \\ \text { Zip Kleen Dry Cleaners } & \text { Santa Barbara } & 1.95 \\ \text { Effie the Tailor } & \text { Santa Barbara } & 2.00 \\ \text { Magnolia Too } & \text { Goleta } & 2.00 \\ \text { Master Cleaners } & \text { Santa Barbara } & 2.00 \\ \text { Santa Barbara Cleaners } & \text { Goleta } & 2.00 \\ \text { Sunny Cleaners } & \text { Santa Barbara } & 2.00 \\ \text { Casitas Cleaners } & \text { Carpinteria } & 2.10 \\ \text { Rockwell Cleaners } & \text { Carpinteria } & 2.10 \\ \text { Norvelle Bass Cleaners } & \text { Santa Barbara } & 2.15 \\ \text { Ablitt's Fine Cleaners } & \text { Santa Barbara } & 2.25 \\ \text { California Cleaners } & \text { Goleta } & 2.25 \\ \text { Justo the Tailor } & \text { Santa Barbara } & 2.25 \\ \text { Pressed 4 Time } & \text { Goleta } & 2.50 \\ \text { King's Cleaners } & \text { Goleta } & 2.50 \end{array} $$ a. What is the average price per shirt washed and ironed in Goleta? In Santa Barbara? b. Draw typical marginal cost and average total cost curves for California Cleaners in Goleta, assuming it is a perfectly competitive firm but is making a profit on each shirt in the short run. Mark the short-run equilibrium point and shade the area that corresponds to the profit made by the dry cleaner. c. Assume \(\$ 2.25\) is the short-run equilibrium price in Goleta. Draw a typical short-run demand and supply curve for the market. Label the equilibrium point. d. Observing profits in the Goleta area, another dry cleaning service, Diamond Cleaners, enters the market. It charges \(\$ 1.95\) per shirt. What is the new average price of washing and ironing a shirt in Goleta? Illustrate the effect of entry on the average Goleta price by a shift of the short-run supply curve, the demand curve, or both. e. Assume that California Cleaners now charges the new average price and just breaks even (that is, makes zero economic profit) at this price. Show the likely effect of the entry on your diagram in part b. f. If the dry cleaning industry is perfectly competitive, what does the average difference in price between Goleta and Santa Barbara imply about costs in the two areas?

Short answer

Short Answer: The average price of washing and ironing a men's shirt is \$2.25 in Goleta and \$1.98 in Santa Barbara. With the entry of Diamond Cleaners, the new average Goleta price drops to \$2.20. In a perfectly competitive market, the higher average price in Goleta suggests that production costs are higher there compared to Santa Barbara.

Step-by-step solution

Count and sum prices in Goleta and Santa Barbara

Calculate the total number of cleaners and sum the prices for each city. Goleta (5): Magnolia Too (\$2.00), Santa Barbara Cleaners (\$2.00), California Cleaners (\$2.25), Pressed 4 Time (\$2.50), and King's Cleaners (\$2.50) Santa Barbara (12): A-1 Cleaners (\$1.50), Regal Cleaners (\$1.95), St. Paul Cleaners (\$1.95), Zip Kleen Dry Cleaners (\$1.95), Effie the Tailor (\$2.00), Master Cleaners (\$2.00), Sunny Cleaners (\$2.00), Casitas Cleaners (\$2.10), Rockwell Cleaners (\$2.10), Norvelle Bass Cleaners (\$2.15), Ablitt's Fine Cleaners (\$2.25), and Justo the Tailor (\$2.25).

Calculate average prices

Divide the sum of the prices by the number of cleaners in each city to find the average price per shirt. Average price in Goleta = (2.00 + 2.00 + 2.25 + 2.50 + 2.50) / 5 = \$2.25 Average price in Santa Barbara = (1.50 + 1.95 + 1.95 + 1.95 + 2.00 + 2.00 + 2.00 + 2.10 + 2.10 + 2.15 + 2.25 + 2.25) / 12 = \$1.98 The average price per shirt washed and ironed is \$2.25 in Goleta and \$1.98 in Santa Barbara. #b. Draw typical marginal cost and average total cost curves for California Cleaners in Goleta, assuming it is a perfectly competitive firm but is making a profit on each shirt in the short run. Mark the short-run equilibrium point and shade the area that corresponds to the profit made by the dry cleaner.#

Draw the cost curves

Since the firm is making a profit in the short-run, the average total cost (ATC) must be lower than the price it is charging. Draw the ATC curve below the price of \$2.25. The marginal cost (MC) curve should intersect the ATC curve at its lowest point (i.e., where the ATC curve is decreasing).

Identify short-run equilibrium and profit area

The short-run equilibrium point is where the MC curve intersects the horizontal line at the given price of \$2.25. The area representing the profit is the vertical distance between the ATC curve and the price (i.e., the difference between the price and the ATC) in the short run, multiplied by the quantity being produced. #c. Assume \$2.25 is the short-run equilibrium price in Goleta. Draw a typical short-run demand and supply curve for the market. Label the equilibrium point.#

Draw demand and supply curves

In a perfectly competitive market, the demand curve should be downward sloping and the supply curve should be upward sloping. The intersection of the demand and supply curves will represent the equilibrium point. The equilibrium price will be \$2.25. #d. Observing profits in the Goleta area, another dry cleaning service, Diamond Cleaners, enters the market. It charges \$1.95 per shirt. What is the new average price of washing and ironing a shirt in Goleta? Illustrate the effect of entry on the average Goleta price by a shift of the short-run supply curve, the demand curve, or both.#

Calculate the new average price

Add Diamond Cleaners to the list of dry cleaners in Goleta (6 total) and calculate the new average price. New average price in Goleta = (2.00 + 2.00 + 2.25 + 2.50 + 2.50 + 1.95) / 6 = \$2.20

Shift the supply curve

The entry of Diamond Cleaners into the market will increase the supply in the short run, causing the supply curve to shift to the right. As a result, the new equilibrium price will decrease, causing the demand curve to also shift. #e. Assume that California Cleaners now charges the new average price and just breaks even (that is, makes zero economic profit) at this price. Show the likely effect of the entry on your diagram in part b.#

Adjust cost curves

With the new average price of \$2.20, California Cleaners will now just break even. This means that the ATC curve will have to touch (not cross) the price of \$2.20. Adjust the ATC curve accordingly in your diagram from part b. #f. If the dry cleaning industry is perfectly competitive, what does the average difference in price between Goleta and Santa Barbara imply about costs in the two areas?# In a perfectly competitive market, differences in prices are due to differences in production costs. The higher average price in Goleta (\$2.25 before Diamond Cleaners, \$2.20 after) compared to Santa Barbara (\$1.98) suggests that costs are higher in Goleta than in Santa Barbara.