Question

Suppose that you own a home remodeling company. You are currently earning short-run profits. (Hint: If this is a perfectly competitive industry, what happens in the long run to the number of firms?) Assume that the home remodeling industry is an increasing-cost industry. In the long-run, what do you expect to happen to:

a. your firm's average cost of production? Why?

b. the price you can charge for your remodeling service? Why?

c. profits in the home remodeling industry? Why?

Answer 1

If the industry is increasing cost industry that means resources are not yet fully utilized and input cost is relatively less than revenue per unit of production. Company is earning super normal profit in the short run.

a) Since the company is has super normal profit more and more firms will enter in the market to gain the profit. This will results in higher demand of the inputs of production in the long run.

Cost of input increases for the same level of output. Hence firm's average cost of production will also increases.

b) In the long run companies average and marginal cost will increases . Price of the product is also dependent on the marginal cost of the firm Since firm needs to maintain normal profit. ( MC = MR). In perfect competition firm's earn normal profit where Marginal cost and marginal revenue is equal. Firm' s price is equal to firm's marginal cost

Hence price of the product will also increases.

c) In the long run new firms will enter in the market and increase the aggregate supply as compare to aggregate demand. it will create competition and leads to reduction in prices. In the long run cost is also increases.

It can be concluded that in the long run profit of the firm will reduce and firm will make normal profit instead of super normal profit.