Question

Suppose that the market for cantaloupes is currently in long-run equilibrium at a price of $3 per melon. A listeria outbreak in cantaloupe crops leads to a sharp decline in the demand for cantaloupes.

a) In the short-run, what will happen to the price of a cantaloupe? Explain and use a graph to illustrate your answer.

b) In the short-run, how will firms respond to the change in the price described in part (a)? What will happen to each producer’s profits in the short run? Explain your answer using a graph. c) Given the situation described in (b), what can we expect to happen to the number of producers in the cantaloupe industry in the long-run? Why?

d) What will the long run equilibrium price of a cantaloupe be? Show your solution in a graph.

Answer 1

Market for cantaloupes is show below in the diagram which is currently in long-run equilibrium at a price of P0 = $3 per melon. Market quantity is Q0 units and each firm is producing q0 units. Now there is a sharp decline in the demand for cantaloupes.

a) In the short-run, this is shown by a downward shift of the demand curve. This shift decreases the market price of a cantaloupe which implies that now each existing firm is supplying less at q1 units when the price they face falls below $3 to a price P1

Price and Price and cost (S) SS cost ($) МC ATC РО MR AR РО Economic loss P1 P1 DD DD1 Quantity Quantity ql q0 Q1 Q0

b) In the short-run, all existing firms will respond by reducing the quantity they supply because now the price is reduced so they travel down along their marginal cost function which is also their respective supply function. This will result in economic losses in the short run because now price is reduced, quantity supplied is reduced so revenue is reduced. In the long run previously, they were not earning any economic profit so when price falls now, they bear losses

c) Given the situation described in we expect that in the long run these loss making units will exit the market and gradually the supply decreases. As this happens, the price rises and economic loss starts falling. At price P0, the market price is restored but now the number of producers in the cantaloupe industry in the long-run has reduced.

d) The long run equilibrium price of a cantaloupe is same as the initial long run price, considering this being a constant cost industry.

Price and Price and cost (S) SS1 SS cost (S) МC P2 РО E3 MR AR PO E2 P1 DD DD1 q1 д0 Quantity Quantity Q2 Q1 Q0