Question

Assume that the gold-mining industry is perfectly competitive. a) Illustrate a long-run equilibrium using diagrams for the gold market and for a representative gold mine. b) Suppose that an increase in jewelry demand induces a surge in the demand for gold. Using your diagrams, show what happens in the short run to the gold market and to each existing gold mine. c) If the demand for gold remains high, what would happen to the price over time? Specifically, would the new long-run equilibrium price be above, below, or equal to the short-run equilibrium price in part b)?

Answer 1

The gold-mining industry is competitive:

a) Illustrate a long-run equilibrium using diagrams for the gold market AND for a representative gold mine.

We can say the market is equilibrium where the supply of gold equals to its demand. At the price of gold is P and the quantity is Q, the market equilibrium in a long run; if the firm earns zero economic profit. It has shown in the following diagram.

b) Suppose that an increase in jewellery demand induces a surge in the demand for gold. Using your diagrams from part (a), show what happens in the short run to the gold market and to each existing gold mine.

The increase in jewellery’s demand leads to an increase in the demand for gold. Therefore, it is shifting the demand curve from D to D1 and in the short run, the price rises from P to P1 and the market output rises from Q to Q1. The mine’s output rises to q1 because of the price now exceeds Average Total Cost (ATC). Thus, the firm makes an economic profits (i.e., green shaded area in the below diagram).

c) If the demand for gold remains high, what would happen to the price over time? Specifically, would the new long-run equilibrium price be above, below, or equal to the short-run equilibrium price in part (b)? Is it possible for the new long-run equilibrium price to be above the original long-run equilibrium price? Explain.

In part (b), the Gold mines earn positive profits, so over time new firms will enter the industry, therefore, the demand will shift to the right and the price reduces to P1, but the price fall to P and it leads to short supply in the market. The costs for new firms are likely to be higher than for older firms, since they’ll have to discover new gold resources. So it’s likely that the long-run supply curve in the gold industry is upward sloping. That means the long-run equilibrium price will be higher than it was initially.If the industry is an increasing cost, then the number of firms increases, input prices are bid up. Hence, the cost curves of an individual firm shift up. The long run supply in this case is upward sloping and the new long run equilibrium price will be above the original price.