Question

Suppose that the chicken industry is in long-run equilibrium at a price of $5 per pound of chicken and a quantity of 300 million pounds per year. Suppose that the Centers for Disease Control (CDC) announces that a chemical found in chicken is causing bacterial infections to spread around the world.

Answer 1

Suppose the chicken industry is in long-run equilibrium at a price of S5 per pound of chicken and the equilibrium quantity is 300 million pounds per year. If the CDC announces that a chemical found in chicken is causing bacterial infections which would spread around the world, then the consumers would demand less chicken at each price level. In the short-run, the demand would decrease and the demand curve would shift leftwards This is shown in the figure below: PRICE (P) D2 Si 300 Quantity (Q in millions) The initial equilibrium was given by the original demand curve (Dı) and the original supply curve (Sı) at point "Eı The decrease in consumer confidence decreases the demand for chicken which shifts the demand curve to the left. The new short-run equilibrium is given by the intersection of Sı' and the new demand curve 'D2'. The resulting equilibrium price and quantity are lower than before Here, in the short-run, firms will respond by reducing the supply (as the new equilibrium price is lower) and running losses. As of now, there is only a movement along the supply curve from 'E1' to 'E2'

In the long-run, some of the firms will respond by exiting the industry as there are negative protts or simply losses accruing to the tims. Fims will keep exting the industry until each firm is earning "Zero-profits" once again. When few of the firms exit the industry, the supply of that particular industry goes down as there are few firms left to serve the market. As a result, the supply of the industry decreases and the supply curve also shifts leftwards (upwards) The following figure shows the short-run and long-run effects of the announcement: PRICE (P) S2 D2 S5. 300 Quantity (Q in millions) The decrease in the supply due to exit of few firms would result in an increase in the equilibrium price (after the change in demand, the price fell) and decrease in the quantity of chickens (a further decrease after the change in demand).

Finally, it can be concluded by looking at the final figure (long-run effects) that the price level will be unchanged (at S5) in the long-run and the quantity will decrease. Initially, firms were supplying chickens at a price of S5. The final equilibrium reflects that the price will be the same. That is, remaining firms will supply chickens at S5 only It can be noted that the price remains same while the quantity supplied changes. This means that the firms produce and sell their entire output of chicken at a fixed price of S5 Therefore, the firms have a "horizontal" supply curve in the long-run as any quantity of chickens is sold at a fixed price of $5