Question

Show graphically the following situation. A typical dairy farm is initially breaking-even. Show the profit-maximizing level of output and labeled it q*. Next, show how a decrease in milk prices due to COVID-19 will affect the dairy farm. You will need to draw another demand curve and any cost curves to show the situation. Will the firm be still breakingeven? Label the new level of output produced by the firm as q2. Assume that the dairy farm is still able to keep producing.

Answer 1

Ans) Perfectly competitive market is where there are many sellers selling homogeneous. Since sellers are too small to influence the market, price is decided by forces of demand and supply.

Price is equal to marginal revenue and also acts as demand curve for individual firm.

A profit maximising firm produces the quantity where MR and MC curve intersect.

If price is above ATC, firms earn positive economic profit. If price is below ATC, firms earn negative economic profit.

If price is equal to ATC, firms earn zero economic profit and firm breaks even.

When price is below ATC, firm will produce only if price is above AVC.

Above graph shows that firm breaks even.

The above graph shows that due to decrease in demand, price has decreased. And firm is earning negative economic profit. But it will continue to produce in short run because price is above AVC.

Above graph shows combined situation in single graph.