If two goods are perfect substitutes, both goods are produced with increasing marginal cost, and for...

If two goods are perfect substitutes, both goods are produced with increasing marginal
cost, and for some reason the marginal cost of producing one of the two goods go up, but
the marginal cost of producing the other good stay the same, what is the effect on the
equilibrium prices of the two goods? Explain your answer carefully.

Expert Solution

The price of the good whose marginal cost has gone up will become costlier as compared to the good whose marginal cost stays the same. Marginal cost is the additional cost incurred by the firm to produce an additional product. The marginal cost goes up means as the firm expands its production the cost will increase making the good more and costlier.

Because the firm is incurring an additional cost it will stop the production at a point where the marginal cost is low or the price of that good will increase. In any of the case, the good will become costlier.

The consumer will be more attracted to the cheaper substitute and this will increase the demand for that substitute product. Due to increased demand, the cheaper substitute will also become costlier and the price of both the goods will be same. But the firm selling good with low marginal cost will make more profit as compared to a firm selling goods with high marginal profit.

Rahul Sunny answered 2 years ago

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