Question

The crop seed market for commercially produced plants such as corn, cotton, soybean, canola etc. used to be close to perfectly competitive before 90s. As will be explained in the next question this market got less and less competitive since then. For the purpose of this question, consider a seed producer in Washington State in 1985 selling corn seeds. Suppose this company is making economic losses.

a. How does the price of corn seeds compare to the average total cost and the average variable cost of producing corn seeds in the short run? Draw the cost curves (average total cost, average variable cost, and the marginal cost) of this representative firm and the price of corn seeds to illustrate its situation in the short run? (10 pts)

b. Now suppose there is a positive demand shock for corn (ie: demand for corn increases) and so the price of corn seeds goes up. The corn seed producer in part-a begins making an economic profit. Draw the cost curves (average total cost, average variable cost, and the marginal cost) of this representative firm and the price of corn seeds to illustrate its new situation? (5 pts)

c. Now that the corn seed producer from part-a is making a profit, what will happen to the corn seed market in the long run? What will happen to the economic profit of an individual corn seed producer? What will happen the quantity supplied by each firm in this market (increase, decrease or ambiguous change?) and the total quantity supplied in the market? (10 pts)

Answer 1

Ans - a) In short run the firm earns economic losses when AC > PRICE (AR=MR). tHE Price is set at the point where SMC = MR =AR under perfect competition.

In the figure - :

AC = average cost curve

AVC = average variable cost curve

SMC = short run marginal cost curve.

LOSS region = PABE

Price = AR =MR . Equilibrium is attained at E where SMC= AR or MR.

OP = Eq price , OQ = Eq qty

Ans - b) The situation of economic profit -:

In the fig- :

The demand curve i.e. AR=MR curve shifts to AR1 = MR1 due to positive demand shock. This shifts up the price from OP to OP1 .

Economic profit - P1E1AB (iT occurs because here P > AC )

New eq at E1. New price = OP1 , New qty = OQ1.

Ans-c) In the long run , the corn industry will earn Normal Profit. The economic profit of individual corn seed producer will decline and he will earn zero economic profits where P=AC . This happens because economic profits by the producer in part b attracts other producers to enter the market . This decreases the market share of every individual and hence the decline in profit.

Quantity supplied by each firm in the market will decrease (due to new entrants)

Qty supplied by the industry will increase because there are more sellers now.

Graphical description of industry in long run-:

The industry earns normal profit where P=AC .