Question

Q.6 As new regulation bans smoking in many areas, the demand for cigarettes has decreased. Now people spend their money on other products (denote as Y). Draw the graphs of the market and representative firm for cigarettes and for the market Y.

a. Show the initial long-run equilibrium in both sectors and in a representative firm in each sector on the graph.

b. Show what happens when demand changes in both sectors and representative firms.

c. Show the long-run equilibrium in both sectors.

Answer 1

(b). show what happens when demand changes in both sectors and representative firms.

In the cigarette market, demand shifts to the left, price decrease, and the representative firm makes the loss. In the Y market, demand shifts to the right, price increase, and the representative firm make profit.

(c). show the long-run equilibrium in both sectors:

Answer:

In cigarette market: since firms in cigarette industry suffer from losses, there will be an incentive for them to exit, As firms exit, supply curves shifts to the left, driving price up to the initial long-run equilibrium price. As for price rises, losses are gradually eliminated and the industry returns to long-run equilibrium.

In Y market: Since firms in industry Y makes profits, new firms will enter the market. As firms enter, the supply curve will shift to the right, driving the price down to the initial long-run equilibrium price. As for price decreases, profits are gradually eliminated and the industry returns to the equilibrium.