Question

Assume that apples are produced in a perfectly competitive market. Grande’s Orchard is a typical firm that grows and sells apples. Currently, Grande earns zero economic profit, and the market price of apples is $10 per bushel.

(a) Draw a correctly labeled graph showing Grande’s demand curve, average total cost curve, and marginal cost curve, and show the profit-maximizing quantity, labeled QG .

(b) Suppose an increase in the popularity of apple cider increases the demand for apples. How will the increase in the demand for apples affect Grande’s economic profit in the short run? Explain.

(c) What will happen to Grande’s economic profit in the long run? Explain.

Answer 1

(a) Market is competitive so a typical firm's demand curve is fixed at market price which means demand for the firm is flat / horizontal at a price of $10. Currently, Grande earns zero economic profit which means the average total cost curve has its minimum value equal to $10 and is equal to price. Marginal cost curve slopes up and meet demand curve at P = $10. The profit-maximizing quantity is labeled QG at which there is no economic profit.

Price and cost ($) MC ATC $101 -------MR = AR QG Quantity Firm

(b) Suppose an event increases the demand for apples. This increases the market price in the short run. This firms takes the price as given so now its demand curve shifts above. ATC is now less than the price so there are economic profits in the short run.

Price and cost ($) MC ATC P1 $10 Profit -------MR = AR - - - - - - - - - QG QG1 Quantity Firm

(c) In the long run, this firm's economic profit will again turn to zero. This is because many new firms will enter the market attracted by short run economic profits of this market. This will increase market supply and gradually reduce the market price which comes back to $10 (constant cost industry). Hence, again, Grande earns zero economic profit which means the average total cost curve has its minimum value equal to $10.