Question

Consider the market for avocados, which is very competitive. Suppose that initially the market is in long-run equilibrium, but that then someone comes up with the idea of making avocado toast, which spreads rapidly and becomes wildly popular.

a) Show the situation in the market for avocados and the situation of a typical avocado producer before avocado toast becomes popular. What are the profits of the typical firm?

b) How would the popularity of avocado toast affect the price and quantity of avocados in the short run? How would it affect the output and profits of a typical avocado producer?

c) What would the introduction of avocado toast do to the equilibrium price and quantity of avocados in the long run? What would it do to the profits of a typical avocado producer in the long run?

Answer 1

The market for avocados is very competitive and is initially in long-run equilibrium, where demand and supply curves are intersecting at a common equilibrium price and quantity.

a) The situation in the market for avocados and the situation of a typical avocado producer before avocado toast becomes popular is shown below. The profits are zero for any firm because in the long run there are zero economic profits

b) The popularity of avocado toast would increase the demand for avocados. This shifts the demand curve to the right and so that both the market equilibrium price and quantity of avocados in the short run are now higher. Since entry is prohibited in the short run, a typical avocado producer faces a higher price and so produces a greater quantity. Each producer therefore enjoys economic profit in the short run.

c) In the long run, as the economic profits are visible to existing firms, new firms will enter the market. This will raise the supply and so supply curve shifts rightward. This reduces the economic profits as the price starts falling and reaches the minimum of long run average cost. Finally, total quantity is increased, price reaches its original level (constant cost industry) and each producer now earns only normal profit.