Question

Suppose you are a farmer producing grain in a perfectly competitive agricultural market. You are currently in the long-run earning zero economic profit. In the blank under each situation presented below, write whether you would expect “entry of new firms” or “exit of incumbent firms” with respect to how each situation would affect the market price of wheat in the industry. Treat each situation separately. Hint: you may need to refer back to Chapter 2 on supply/demand. (Each blank is worth 3 points.)

a) there has been a decrease in consumer income (grain is considered a normal good) _______________________________________________________________

b) there has been a noticeable decrease in the number of buyers of grain _______________________________________________________________

c) buyers of grain are expecting the price of this product to decrease soon _______________________________________________________________

d) labor costs are increasing in the market for salt, an assumed complement good for buyers of grain _______________________________________________________________

e) a new medical study reveals that consumption of grain products lowers the risk of stroke and heart disease _______________________________________________________________

Answer 1

a)An increase in consumer income will lead to an increase in the demand for grain and hence price of wheat increase.Firms will earn higher profits and hence new firms will enter the market.

b) A decrease in no. of buyers will lead to a decrease in the demand for grain and hence price of wheat falls.Firms will incur loss and hence some incumbent firms will exit the market.

c) Buyers will think that they will buy grain once the price falls .It will lead to a decrease in the demand for grain and hence price of wheat falls.Firms will incur loss and hence some incumbent firms will exit the market.

d)An increase in labor cost for salt will lead to an increase in price of salt which will lead to a decrease in demand for salt.Since salt and grain are complements so demand for grain also falls and hence price of wheat falls.Firms will incur loss and hence some incumbent firms will exit the market.

e) It will lead to an increase in the demand for grain and hence price of wheat increase.Firms will earn higher profits and hence new firms will enter the market.