Question

Suppose the market for fresh pork is a competitive market. Initially, it is operating at its long-run competitive equilibrium at a market price of $50. Owing to the spread of COVID-19, many people turn to buying frozen meat once a week rather than fresh pork every day. As a result, the market price of fresh pork reduces to $30. a. With the aid of a pair of market-and-firm diagrams, illustrate how this would affect the equilibrium price and quantity in the fresh pork market and the output of a typical butcher of fresh pork in the short-run. b. Suppose, for the situation in (a), the average cost of a typical butcher of fresh pork is $40, which includes $15 on buying meat from suppliers, $12 on paying rent, $8 on paying hourly wages on staff, and $5 on other costs. Explain whether a typical butcher should shut down in the short run. (2 marks

Answer 1

(a) As shown in the first panel of figure 1, the initial demand and supply curves are D and S respectively. The equilibrium price is determined at their intersection (point e).

Because of Corona, the demand falls and the demand curve shifts down (from D to D'). This results in a fall in price from $50 to $30 as shown in the first panel of the diagram.

This initial price of $50 is taken by the butcher. Initially, the butcher was operating at a longrun equilibrium level. That is the price of $50 is equal to the average cost, since longrun equilibrium necessitates Price = MR = average cost. Hence, with the market price of $50, the butcher was selling Oq* level of meat.

When price reduces to $30, the new profit maximizing level of output is determined at Price (MR) = MC. At this price, the profit maximizing quantity is Oq1 as shown in the diagram.

(b) The average cost = $40, out of which the variable components are $15 (buying meat from supplier) + $12 (paying rent) + $8 (paying hourly wages) = $35. The other cost of $5 may be variable, which is not clear because it simply says other cost. However, the above variable component (i.3., average variable cost of $35) is greater than the new price ($30). In other words, the butcher will not be able to cover the average variable cost in the short run and hence the butcher must shut down.