Question

Soybeans are a homogenous product, produced by a large number of farmers. Pricing is transparent, making this a perfectly competitive industry. Seed, fertilizer, land and machinery are the key cost items. a. Are fertilizer costs a variable cost or a fixed cost? How about seed costs? Machinery costs? Explain. Assume that all producers have an identical cost structure. Moreover, suppose that there is a large pool of potential entrants who, if they were to enter this industry, would operate under cost conditions identical to those of active producers. It takes about 2 years to start a new productive soybean farm. Initially, we’re in a long-run equilibrium where price equals full- reinvestment average total cost (FRATC). Now, demand unexpectedly surges due to an increase in the perceived health benefits of a diet with plenty of soy. Although this was initially unexpected, it proves to be permanent. In addition, the price of fertilizer unexpectedly and permanently declines. Let’s look at the soybean industry 3 years after these events and compare it to the initial situation. The cost of capital has remained stable for the entire period. For each variable listed below, determine if it is “greater than,” “less than,” “the same as” it was 3 years ago, or “We can’t tell for sure from the information given.” Briefly explain your reasoning in the space below.

b. Market price.

c. Number of farms.

Answer 1

Solution :

Part a :

Fertilizer costs and seed costs are variable cost. Machinery cost are fixed cost.

Variable costs are those costs which change with the change in level of production. For example, if production declines then these costs also decline.

Fixed costs are those costs which are incurred even when there is no production. They remain constant throughout the production.

Fertilizer is used according to the scale of production. If more is produced, more fertilizer is used. Hence, fertilizer is a variable cost. Same goes for seeds. Seeds are used according to how much the farmers want to produce. If they do not want to produce then there would be no cost on seeds or fertilizers. Hence, they both are variable cost.

Machinery is a fixed cost because machinery is bought specifically and its quantity is not changed in the middle of production process. The cost on machinery stays the same. It is incurred before production starts and stays constant even when there is no production.

Part b :

Market Price - "We cant tell for sure from the information given"

Reason : Since the market was already in equilibrium when demand surged, the demand curve shifted to the right and made a new equilibrium where price must've been higher. At the same time, the cost of fertilizer decreased which made the cost of production fall. Therefore, supply increased and shifted to right. This would mean that price would have fallen again. Since we do not know the exact magnitude of shifts in the demand and supply curve, we cannot tell what the price has become now.

Part c :

Number of farms : "Greater than what it was 3 years ago"

Reason :

As demand had surged and price would've increased, the existing farmers should have started making economic profits. As it only takes 2 years to start production of soybeans, many new farms would've started production of soybeans, attracted by the economic profits. Hence, the number of farms would have increased in the last 3 years.