Question

Healthy Potato is a firm in a competitive industry with a large number of potato producing firms.

a. Draw a graph to show the initial equilibrium.

b. If there is bad news that eating too many potatoes can cause cancer. What will happen in both short run and long run? Describe how that industry adjusts to this situation. Explain your answer graphically, showing both the typical potato producing firm's marginal cost and average total cost curves, as well as the market supply and demand curves. Distinguish between the short run and the long run

Answer 1

a.

In perfect competition, firms charges the price as determined by the market forces and price charged is equal to the marginal cost.

B. When there is bad news that eating too many potatoes can cause cancer, people will reduce demand and this will shift the market demand curve leftwards. Overall, price will reduce and quantity will fall. The fall in price will reduce the marginal revenue of individual firms.

This reduction in demand will cause economic losses to seller in the short - run as displayed by the following figure :

In the long run, however there will be no losses and firm will return back to zero economic profits. This is because in the long run there is free entry and exit of firms. If firms face losses in short run, many firms will leave the market which will push price up and there will be zero economic profits in the long run.