Question

This question asks you to consider the market for vitamins in the United States. For this question, please assume that there are many small vitamin manufacturers in the U.S. market, so that the market is perfectly competitive.

a)Begin by depicting the market for vitamins in long-run equilibrium. Using two diagrams, one to represent the market for vitamins, and a second to represent the costs of a typical vitamin manufacturer, illustrate the current price, quantity and profits of a typical vitamin manufacturer. Explain why you have drawn the curves as you did.

b) Suppose that the recent health care reform includes a provision providing substantial insurance premium discounts for any U.S. citizen who takes a daily vitamin. Show how such a mandate affects the short-run market equilibrium, price, and profits of a typical vitamin manufacturer. Using one diagram for the vitamin market and a second for a typical firm.

c) Will the scenario you have described in part (b) be a stable long-run equilibrium? Why or why not? Once again using separate diagrams for both the industry and a typical firm, illustrate the new long run equilibrium for the vitamin market.

d) To avoid the possibility you discuss in (c), the vitamin industry has proposed a licensing scheme. Only licensed vitamin manufacturers will be allowed to sell vitamins in the United States, and the number of licenses available will be limited. How would such a licensing requirement affect your answer to part (c)? Why?

Answer 1

(a) In following graph, left panel depicts the market and right panel depicts individual firm. Intial long-run equilibrium is at point A for the market, where initial market demand D0 intersects initial market supply S0, with market price P0 and quantity Q0. Since the firm is a price-taker, it accepts P0 as its own price and maximizes profit by equating P0 with marginal cost curve (MC). Since this is a long-run equilibrium, price equals average total cost (ATC) curve, so firm's equilibrium is at point a where P0 intersects MC & ATC with firm output q0.

(b) The mandate will increase the demand, which will shift market demand curve rightward to D1, intersecting S0 at point B with higher price P1 and higher market quantity Q1. Accordingly firm equilibrium is at point b where P1 intersects MC with firm output q1. Since P1 > ATC, there is a short run profit.

(c) The short-run economic profit will attract new entry which will increase market supply, shifting market supply curve rightward until it is at S1, intersecting D1 at point C with original price P0 but still higher quantity Q1. Accordingly, firm's quantity falls to q0, restoring equilibrium at point a.

(d) A licensing scheme introduced in a perfectly competitive market introduces some amount of monopoly or restrictions . Since number of license available will be limited , that will reduce supply in the market . There will be many buyers now in comparison to the number of sellers . So a licensing scheme causes price to rise . In the long run firms incur economic profits if limited license are provided . Licensing fee is a fixed cost which does not alter the marginal cost . It will shift the average total cost curve upward . If the firms are earning zero economic profit in short run , then price and output in short run remain unaltered . Few firms go out of market in long run who do not get the license , and then others earn positive economic profit .