Question

(a) Firm (b) Market Price MC 10 . 3,000 Quantity/ time Quantity/ time Case #1: If the input costs for MRI services decreased across all firms, then the short- run price would decrease, increase, or stay the same? Case #2: If the input costs for MRI services decreased across all firms, then the long-run price would decrease, increase, or stay the same? And: For each of these two cases, please explain how you got to the answer.

Answer 1

Case: 1. The figure shows the longrun equilibrium of firms and industry. In longrun all firms are operating at the lowest point of their ATC. In other words each firm is operating at minimum efficient scale. As the firms are operating at full capacity they are not able to increase the volume of output in shortrun. The expansion of output requires additional plant, machinery, labour and raw materials.

The time is not enough for the firms to build additional plant and install additional machinery and equipments. The firm cannot go beyond the optimum level of output. If they do so by using the available capacity intensively, the total cost increase. Thus each firm’s production remains the same and thus the industry supply curve does not shift to the right in shortrun. The new firms cannot enter into the industry in shortrun in order the reap the cost advantage. Thus the industry supply is fixed in shortrun. Unless the supply curve does not shift to the right with fall in cost, the market price of the product remain the same in shortrun.

Answer: The shortrun price would remain the same.

Case: 2. In shortrun the positive profit from the cost reduction attracts new firms to the industry. The entrance of new firms and the expansion of output by the existing firm through the expansion of productive capacity increase the market supply. Thus the market supply increase and the market supply curve shift to the right in longrun. The increase in supply decreases the market price. In short a cost reduction in shortrun increases the market supply and thereby decreases the market price in longrun.

Answer: The longrun price would decrease.