Question

Bestmilk, a typical profit-maximizing dairy farm, is operating in a constant-cost, perfectly competitive industry that is long-run equilibrium.
(a) Draw correctly labeled side-by-side graphs for the dairy market and for Bestmilk and show each of the following.
(i) Price and output for the industry
(ii) Price and output for Bestmilk
(b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs in part (a), show the effect of the decrease in income on

Answer 1

Answer:

a. (i). See the labelled diagram on item (A) on the attached

   (ii). See the labelled diagram on item (A) on the attached

b. (i). See the labelled diagram on item (B) on the attached

   (ii). See the labelled diagram on item (B) on the attached

   (iii) See the labelled diagram on item (B) on the attached

c.      For Bestmilk to continue to produce in the short run, either Price (P) is equal to or less than average variable cost (AVC) that is, (P>=AVC) or price (P) is greater than average total cost (ATC), that is (P>ATC)

d. (i). The initial long run equilibrium will be maintained

   (ii). The original profit maximizing output will be maintained.

   (iii) The number of firms will reduce in response to the elimination of the      super-normal profit that initially attracted to the industry in the short run.  

Explanation:

b. (i) A decrease in the consumer income will force price in the industry to drop from P1 to P2 and output will naturally follow the downward trend from Q1 to Q2.

   (ii) Both the profit maximizing price and quantity will fall to a new level for Bestmilk.

    (iii) A decrease in the consumer income will make Bestmilk to operate at a loss as shown in the shaded area of the attached file.

c. For Bestmilk to continue to produce in the short run, either the price (P) charged for the product should be greater than or equal to the variable cost per unit what this means is that P>= AVC or the price (P) charged for the product is greater than average total cost. i.e. P>ATC

d. (i). The initial long run equilibrium will be maintained

   (ii). The original profit maximizing output will be maintained.

   (iii) The number of firms will reduce in response to the elimination of the      super-normal profit that initially attracted to the industry in the short run.  

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