Question

2. A perfectly competitive potato farm is currently in long run equilibrium.

a. Graph the firm in long run equilibrium. Be sure to label all of the curves and the profit maximizing price and quantity.

b. The demand for potatoes increases. Draw a new graph that shows the impact on an individual firm. Be sure to shade the area of loss or profit.

c. Draw a new graph that shows how the firm and the industry adjusts to a new long run equilibrium.

d. How did the price and quantity in part A change in Part C? Explain your response.

Answer 1

2. a. The firm in long run equilibrium is shown below. Current price is P0 and market quantity is Q0. Each firm produces q0 units.

Price and cost ($) Price and cost ($) MC ATC PO ---- ------ -- -------MR = AR Q0 Quantity 90 Quantity Market Firm Initial market condition (long run equilibrium)

b. The demand for potatoes increases. This shifts the demand curve in the diagram for market. New price is P1 which causes each firm to supply more at q1 and earn economic profit. This is because firm cannot influence the price and produces what it can at the given price using MC curve

Price and cost ($) Price and cost (5) MC ATC DD DDI MR = AR --PI-' Economic profit PO Quantity Quantity QO Q1 a) Market | 70 71 b) Single firm Figure 1 Increase in demand and short run economic profits

c.In the long run, new firms enter the market which increases the market supply and causes the price to decline. This results in decreasing the profit so that all firms now earn no economic profit in the new long run equilibrium. Existing firms however produce the same but due to greater number of firms total production increases to Q1

Price and cost ($) SS S'S' Price and cost ($) MC ATC PO ---- --------------POE-- -------MR = AR D'D' QO Q1 Quantity 90 Quantity Market Firm Initial market condition (long run equilibrium)

d. Market price does not change. Market quantity increases due to increased number of firms. However since price is unchanged each firm produces the same output level