Answer to Question #99040 in Microeconomics for Luigi

Question

“Healthy Ltd” is a small producer of potatoes. The potatoes market is a competitive industry populated by a large number of small firms. At present the industry is away from its “long-run” equilibrium and Healthy Ltd is making economic losses.

a) Draw a graph showing the market demand for and supply of potatoes and illustrate the current position of Healthy Ltd. Is it certain that Healthy Ltd will cease to produce potatoes? Explain your answer.

b) How will the market for potatoes adjust in the long-run and in what sense will the long-run equilibrium prove efficient?

c) How will the market adjust to a serious study that reveals the health benefits of potatoes? Explain using appropriate analysis.

Answer 1

a) The market demand is represented with the downward-sloping curve, and the supply of potatoes is represented with the upward-sloping curve, they intersect at the equilibrium point. The current position of Healthy Ltd is in equilibrium point, because it is a price-taker. Healthy Ltd will cease to produce potatoes only if its average variable cost is above the market price (P < AVC).

b) In the long-run some firms will exit the industry, the supply will decrease, as a result the equilibrium price will increase, and the equilibrium quantity will decrease. The long-run equilibrium will prove efficient, because all remaining firms will receive zero profits.

c) If a serious study reveals the health benefits of potatoes, then the demand will increase, as a result both equilibrium price and quantity will increase.