Question

A constant cost, perfectly competitive market is in long-run equilibrium. At present, there are1,000 firms each producing 400 units of output. The price of the good is $60. Now suppose there isa sudden increase in demand for the industryʹs product which causes the price of the good to riseto $64. In the new long-run equilibrium, how will the average total cost of producing the goodcompare to what it was before the price of the good rose?
A) The average total cost will be higher than it was before the price increase because ofdiseconomies of scale arising from the increased demand.
B) The average total cost will be lower than it was before the price increase because ofeconomies of scale.
C) The average total cost will be the same as it was before the price increase.
D) The average total cost will be higher than it was before the price increase since the increase indemand will drive up input prices.

Answer 1

Answer:

The correct answer is option A.

Explanation:

Diseconomies of scale refers to the situation when the average cost of production increases with the scale of production.

In a constant perfectly competitive market that is operating at long run equilibrium, the price is $60. Each firm is producing 400 units of output.

Since the firms are in long run equilibrium, the price will be equal to the average total cost.

Now, with an increase in the demand for the product the price increases to $64.

The individual demand curve of the firms will move upwards. This will cause the average total cost to increase as well. The new ATC will be $64.

This happens because of diseconomies of scale involved in the increasing the volume if output after a certain point.