1 Bestmilk a typical profitmaximizing dairy firm is

1. Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry in long-run equilibrium.

P P MC p LRATC MR=D=AR=P S P D Q Q q Q Bestmilk Firm Market/Industry (a) Draw correctly labeled side-by-side graphs for the dairy market and for Bestmilk and show each of the following. (i) Price and output for the industry (ii) Price and output for Bestmilk

P P LRATC MC p S MR=D=AR=P P P 1 D q Q Bestmilk Firm Q 1 Q Q Market/Industry (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (i) Price and output for the industry

P P LRATC MC p p 1 S MR=D=AR=P P MR 1=D 1=AR 1 =P 1 D 1 D q 1 q Q Bestmilk Firm Q 1 Q Q Market/Industry (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (ii) Price and output for Bestmilk P and Q go down.

P Area of loss: p 1 p 2 AB p 1 p 2 A S LRATC MC p P MR=D=AR=P P MR 1=D 1=AR 1 =P 1 B D 1 D q 1 q Q Bestmilk Firm Q 1 Q Q Market/Industry (b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs, show the effect of the decrease in income on each of the following in the short-run. (iii) Area of loss or profit for Bestmilk

P P LRATC MC p P 1 S AVC MR=D=AR=P P MR 1=D 1=AR 1 =P 1 D 1 D q 1 q Q Bestmilk Firm Q 1 Q Q Market/Industry (c ) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run? Anytime a question asks whether or not a firm should produce, the student MUST draw an AVC curve for the firm.

P P LRATC MC p B P 1 S AVC MR=D=AR=P P MR 1=D 1=AR 1 =P 1 C q 1 q Q Bestmilk Firm D 1 D Q 1 Q Q Market/Industry (c ) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run? If the price (Point B) is greater then the AVC (Point C) at the profit-maximizing quantity, Bestmilk should continue to produce.

P P MC p P 1 LRATC AVC MR=D=AR=P P MR 1=D 1=AR 1 =P 1 S 1 S D 1 D Q 1 Q Q Q Bestmilk Firm Market/Industry (d) Assume that the industry adjusts to a new long-run equilibrium. Compare the following between initial and the new long-run equilibrium. (i) Price in the industry Because economic profits are less than zero, firms will exit the market. q 1 q

P S 1 S P MC p P 1 LRATC AVC MR=D=AR=P P MR 1=D 1=AR 1 =P 1 D 1 D q 1 q Q Bestmilk Firm (ii) Output of a typical firm Q 1 Q Q Market/Industry Since Bestmilk firm is a price taker and will take the market price, the firm quantity returns back to the original “q. ”

P P MC p P 1 LRATC AVC MR=D=AR=P P MR 1=D 1=AR 1 =P 1 S 1 S D 1 D Q 2 Q 1 Q Q Q Bestmilk Firm Market/Industry (iii) The number of firms in the dairy industry. q 1 q Looking at the market graph, as the number of firms exit the industry, quantity goes down.