Question

Suppose that the market for eggs is initially in long-run equilibrium. One day, enterprising and profit-hungry egg farmer Atkins has the inspiration to fit his laying hens with rose-colored contact lenses. His inspiration is true genius—overnight his egg production rises and his costs fall.

1) Will farmer Atkins be able to leverage his inspiration into greater profit in the short run? Why?

2) Farmer Atkin’s right-hand man, Abner, accidentally leaks news of the boss’ inspiration at the local bar and grill. The next thing Farmer Atkins knows, he’s being interviewed by Brian Williams for the NBC evening news. What short-run adjustments do you expect competing egg farms to make as a result of this broadcast? What will happen to the profits of egg farmers?

3) In the long-run, what will happen to the price of eggs? What will happen to the profits of egg producers (including those of farmer Atkins)?

4) Explain how, in the long-run, competition coupled with the quest for profits ends up making producers better off only for a little while, but consumers better off forever.

Answer 1

1) Yes, in the short-run, the farmer makes greater profit because the short run is characterised as the time period in which prices remain the same. As Atkins produces more, there is a fall in costs but the prices do not come down. So, for each egg sold, the margin between cost and price become higher. This margin is nothing but the profits of the farmer. So profits increase in the short run.

2) As the new technique is leaked, all other farmers produce eggs with this new method to increase production and reduce their costs. Since it is the short run, the prices remain constant and as a result all the farmers in the industry earn higher profits. The figure in the following image shows this situation.

The average cost curve AC₁ shifts down to AC₂ as farmers produce with new technique. Prices remain fixed at P₁. The shaded area shows the super-normal profits earn by farmers in the short-run.

3) The long run is the time period when there are no fixed values. After a time, price of an egg will follow the costs of producing it. There will be downward pressure on the prices and it will come down to a point that is consistent with lower (new) level of costs. So the higher margin observed in the short run will start diminishing and ultimately become 0. Hence in the long run, no farmer earns super-normal profits. All of them earn only normal profits (which includes all explicit and implicit costs.) Diagramatically, the price line P₁ starts to shift down to a point where it is tangent to new cost curve.

4) The higher profit margins in the short-run attracts other farmers to produce and supply eggs. This results in higher supply of eggs in the market because (a) new farmers enter the market and (b) existing farmers increase their supply to earn more. It leads to higher competition among the farmers in the market. To increase the market share, each farmers try to sell more by reducing the price a bit. This process goes on till the price of an egg reaches the cost of producing it. The new price will be lower than the earlier price and the overall supply will be higher in the market. Therefore, while the producer farmers gain int the short run only, consumers are better-off forever because they get eggs more cheaply now.