On a diagram, show the long-run equilibrium for both firm and industry under perfect competition. Now...

On a diagram, show the long-run equilibrium for both firm and industry under perfect competition. Now assume that the demand for the product rises. Show the new short term effects and discuss what might happen after the market responds.

Expert Solution

Below is the long-run equilibrium for both firm and industry under perfect competition. Price is set at P0 and market quantity is Q0. Demand is DD and supply is SS. Firm produces q0 at a price of P0. There is no economic profit.

Now assume that the demand for the product rises. As demand shifts to DD1, price rises to P1 and quantity rises to Q1. Each firm now produces q1 units at a price of P1 and has economic profits.

As there is a transition from short to long run new firms can enter the market. This shifts the supply curve to the right. Price starts falling and this causes economic profit to decline. Entry stops when economic profits are no longer available and price is again P0. Market quantity is Q2 but each firm produces q0.

Rahul Sunny answered 6 months ago

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