Question

Assume that a perfectly competitive hand sanitiser market is in long-run equilibrium. The price of hand sanitisers is observed to increase during the COVID 19 pandemic, and then it returns back to its normal price after the pandemic.Include in your discussion the profit levels in each case.

Answer 1

* The equilibrium price is determined at a point where the DD' and SS' curve instersects at point A. The equilibrium industry price is P₂ and the industry equlibrium output is Q₂. We know that the industry is perfectly competitive. But, however, during the pendemic, the demand for hand sanitizer has increased suddenly and it becomes a kind of essential product. This would shift the demand curve to the right and so the price will also rise from P2 to upward P3. Now, each firm will produce q3 of output. This will raise the profit of the firm since the ATC is less than the price. Now, each firm will be earning FB amount of profit. However in the long run two things may happen.

* First attracting by this profit, new firms will enter the industry and that will shift the SS' curve to the right.and that will reduce the price level again to the previous equilibrium level where the price was P2 and the profit of each firm will come down to the normal level.

* Second possibility is that, as soon as the pendemic is over the, demand will come down again to the DD' level and that will cause the price to fall to P2 level. This fall in the price will reduce the profit level of the firm and now each firm will be earning normal profit.

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