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1.Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry in long-run equilibrium.

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Presentation on theme: "1.Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry in long-run equilibrium."— Presentation transcript:

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2 1.Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry in long-run equilibrium.

3 P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry (a) Draw correctly labeled side-by-side graphs for the dairy market and for Bestmilk and show each of the following. (i) Price and output for the industry (ii) Price and output for Bestmilk P

4 (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P (i) Price and output for the industry D1 Q1 P1

5 (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P (ii) Price and output for Bestmilk D1 Q1 P1 p1 MR1=D1=AR1 =P1 q1 P and Q go down.

6 (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (iii) Area of loss or profit for Bestmilk P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P D1 Q1 P1 p1 MR1=D1=AR1 =P1 q1 p2 A B Area of loss: p1p2AB

7 (c ) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run? Anytime a question asks whether or not a firm should produce, the student MUST draw an AVC curve for the firm. AVC P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P D1 Q1 P1 MR1=D1=AR1 =P1 q1

8 (c ) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run? If the price (Point B) is greater then the AVC (Point C) at the profit-maximizing quantity, Bestmilk should continue to produce. P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P D1 Q1 P1 MR1=D1=AR1 =P1 AVC B C q1

9 (d) Assume that the industry adjusts to a new long-run equilibrium. Compare the following between initial and the new long-run equilibrium. (i) Price in the industry P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P D1 Q1 P1 MR1=D1=AR1 =P1 AVC Because economic profits are less than zero, firms will exit the market. S1 q1

10 (ii) Output of a typical firm Since Bestmilk firm is a price taker and will take the market price, the firm quantity returns back to the original “q.” P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P D1 Q1 P1 MR1=D1=AR1 =P1 AVC S1 q1

11 (iii) The number of firms in the dairy industry. Looking at the market graph, as the number of firms exit the industry, quantity goes down. P Q Q S D Q p LRATC MC q MR=D=AR=P P Bestmilk FirmMarket/Industry P D1 Q1 P1 MR1=D1=AR1 =P1 AVC S1 q1 Q2


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