Answer to Question #140429 in Microeconomics for Annie

Question

Q1: What three conditions would result in the long-run supply curve for a domestically produced good being horizontal? For each explain what happens when the condition does not hold.
Q2: Navel oranges are grown in California and Arizona If Arizona starts collecting a specific tax per orange from its firms, what happens to the long-run market supply curve?

Answer 1

Q1: An horizontal supply curve means that there is perfect competition in the market where any increase in demand for goods can be met without increasing the prices. Conditions under which this would occur are.

1. Many suppliers produce and supply the same product. In the long-run, buyers will perceive the products as perfect substitutes for each other and will not have any preferences for a particular product. Firms cannot be able to charge higher prices to meet their production costs, thus in the long-run many firms try to differentiate their goods to create a higher demand for their product and competitive advantage.
2. Buyers have enough information when purchasing goods. This can not hold for long since information asymmetry will always occur in the long-run where one buyer has more information about the market than the rest, thus leading to loss of economic profits. It can also lead to a monopolistic market in the long-run as one buyer gains more knowledge about the market than the rest.
3. There are no barriers to entry into the market by new suppliers. This hypothesis does not last long. Eventually, when the market gets saturated by the entry of new firms, the demand curve of each firm will shift downwards bringing down the price, average revenue, and the marginal revenue curve. This means that in the long-run firms will make zero profits.

Q2: Imposing a tax on a supplier or buyer has the same effect in the short-run. If a higher tax rate is imposed in Arizona State, the suppliers will obtain a price less than the tax and increase the price buyers pay by less than the tax. This will create a fall in the quantity traded as prices rise. The loss in supplier and consumer surplus will depend on the elasticity of the demand curve. The lower the elasticity the higher the loss in consumer surplus, and the lower in producer surplus. In the long-run, since the supply curve is completely inelastic, the consumers will pay all the tax. Producer surplus will remain zero and there will be no profits made.