[2b] If Bob, in a perfectly competitive industry sees a price rise from equilibrium, resulting from...

[2b] If Bob, in a perfectly competitive industry sees a price rise from equilibrium, resulting from an increase in market demand, what will happen in the short run in his firm? Graph and explain both conditions.

Expert Solution

Consider the image above for the graphical changes in the perfectly competitive market. Equilibrium is originally at the intersection of the demand and supply curve, with price at P0 and quantity at Q0. With an increase in market demand, the demand curve is pushed out to Demand', resulting in an increase in both prices and quantity demanded. As a result, in the short-run, the firms in the perfectly competitive market now start earning supernormal profits. Firms are now able to charge a greater price for the product with the same cost of production, resulting in them earning over just normal profits. However, in the long run, these profits attract further firms into the market. This pushes out the supply curve to Supply', and lowers the price back down to the original P0. Now again, firms are able to earn just normal profits to stay in the market.

Rahul Sunny answered 1 year ago

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