Answer to Question #105390 in Microeconomics for s

Question

Consider the perfectly competitive Corn industry. It is initially in long run equilibrium at quantity Q0 and price P0.
a) Draw a supply and demand diagram for the Corn market showing this equilibrium.
b) Draw a diagram for a typical firm in its initial long run equilibrium, showing its Marginal Cost, Average Total Cost, and Long Run Average Cost curves. Are any profits being made by this firm?
c) A major use for Corn in Canada and the United States is to produce ethanol for use as a gasoline additive. Suppose that a new technology allows for the production of ethanol from trees, which is MUCH more efficient than producing ethanol from Corn. What happens to your diagram in part (a)? Use your diagram from part (b) to show how the firm reacts to this new situation. Are any profits being made by this firm?
d) Explain how this industry adjusts to its new long run equilibrium using both the diagrams from parts (a) and (b). (You may assume that it is a constant cost industry)

Answer 1

a) In equilibrium the supply and demand curves will intersect in the equilibrium point at Q0 and P0.

b) In the long run all firms receive normal (zero) profits, because at profit-maximizing point MR = MC = P = ATC.

c) In this case the demand for corn will decrease, as a result both equilibrium price and quantity will decrease. The firm will face losses, because P < ATC.

d) In the lonfg run the supply will decrease, because some firms will exit the industry, so the equilibrium quantity will decrease, but the equilibrium price will increase back. As a result all remaining firms will receice normal (zero) profits again.