Answer to Question #168293 in Microeconomics for Chhavi Nagar

Question

Suppose a profit-maximizing rice -growing farmer is currently producing 100 bags of rice.Average revenue(AR),Average total costs(ATC) and total fixed costs(TFC) are $10,$8 and $200 respectively.Assume that the market for rice is perfectly competitive.Answer the following:

(a).Is the prevailing market condition favorable for the farmer to continue production or should be shut down his production facility?Explain your answer by drawing suitable graphs and highlight the short-run equilibrium for both the farmer and the rice industry.

(b).How will the perfectly-competitive for rice change in the long run?What would then be the long-run equilibrium in this case?Explain your answer by drawing suitable graphs and highlight the long-run equilibrium for both the farmer and the rice industry.

Answer 1

(a) profit= output *price

$=100(10-8)=200$

Marginal Cost equals Marginal Revenue for profit maximization,hence marginal revenue equals average revenue in competitive market.

Marginal Cost=$10$

Abc=vc/Q=$800-100/100=6$

Efficient scale scale of production occurs when average cost =marginal cost. The efficient scale of the firm is less than 100units. In this case the industry is thriving well as it is making profit and has efficient scale of production . The market is then favourable for the farmer to continue with the production.

The total amount of supply by the firms will be equal to the total amount of consumers demand for rice in a short run competitive equilibrium.In order to maximize profits the rice industry should set marginal revenue equal to marginal cost (MR=MC) whereby MR is the slope of the revenue curve and equal to the demand curve (D) and price (P).

(b)

In the long-run equilibrium, an increase in demand for rice will create an economic profit in the short run and create entry of other farmers and firms in the industry. A decrease in demand for rice will lead to a negative economic profits in the short run and force some farmers and firms to exit the rice industry in the long run.

The long-run equilibrium for a perfectly competitive market occurs when marginal revenue equals marginal costs, which is also equal to average total costs.

In a long run equilibrium all firms in the rice industry will achieve a long run equilibrium as well as the industry. The firms will earn normal profits as the output is produced at a possible cost and selling price covers marginal Cost.