Answer to Question #275359 in Microeconomics for khashayar

Question

2. The market for fertilizer is perfectly competitive. Firms in the market are producing output but are currently incurring economic losses.

a) How does the price of fertilizer compare to the average total cost, the average variable cost, and the marginal cost of producing fertilizer?

b) Draw two graphs, side by side, illustrating the present situation for the typical firm and for the market.

c) Assuming there is no change in either demand or the firms’ cost curves, explain what will happen in the long run to the price of fertilizer, marginal cost, average total cost, the quantity supplied by each firm, and the total quantity supplied to the market.

Answer 1

a)If firms are currently incurring economic losses, price must be less than average total cost. However,

because firms in the industry are currently producing output, price must be greater than average

variable cost. If firms are maximizing profits, price must be equal to marginal cost.

b)The present situation is shown in the figure below. The firm is producing q₁ units of output at a price P₁

c)Since firms are incurring

losses, there will be exit in this industry. This means that the market supply curve will shift to the left,

increasing the price of the product. As the price rises, the remaining firms will increase quantity supplied;

marginal cost will increase. Exit will continue until price is equal to minimum average total cost. Average

total cost will be lower in the long run than in the short run. The total quantity supplied in the market

will fall. The figure in b shows how the market will adjust in the long run