The market for fertilizer is perfectly competitive. Firms in the market are producing output, but they are currently making economic losses.
a. How does the price of fertilizer compare to the average total cost, the average variable cost, and the marginal cost of producing fertilizer?
I would think that average total cost and the average variable cost would be greater than the price of fertilizer. The marginal cost would be equal to the price of fertilizer. Is this correct?
c. Assuming there is no change in demand or the firms' cost curves, explain what will happen in the long run to the price of fertilizer, marginal cost, average total cost, the quantity supplied by each firm, and the total quantity supplied to the market.
In the long run, the price of fertilizer will decrease, the marginal cost will decrease, the average total cost will decrease, the quantity supplied by each firm will decrease, and the total quantity supplied to the market will decrease. This is because firms will exit the market due to the economic losses they are making, leading to a decrease in the supply of fertilizer.
a. You're correct in thinking that the average total cost and average variable cost would be greater than the price of fertilizer. In a perfectly competitive market, firms will continue producing as long as the price of the good exceeds the average variable cost. However, in this scenario, the firms are experiencing economic losses, which means the price must be below their average total cost.
The marginal cost refers to the additional cost of producing one more unit of fertilizer. In a perfectly competitive market, firms will produce where their marginal cost equals the market price. So, in this case, if firms are making economic losses, it suggests that the price of fertilizer is below the marginal cost of production.
c. In the long run, economic theory suggests that firms will exit the market if they are consistently making economic losses. This would lead to a decrease in the quantity supplied by each firm and the total quantity supplied to the market. As firms exit, the supply of fertilizer in the market will decrease, which might eventually lead to an increase in the price of fertilizer.
However, if there are no changes in demand or the firms' cost curves, the market for fertilizer will eventually reach equilibrium in the long run. This means that the price of fertilizer will adjust until it reaches a level where the firms are earning zero economic profit. In this equilibrium, the price of fertilizer will be equal to the average total cost and average variable cost, and firms will produce where their marginal cost equals the market price.
So overall, in the long run, we can expect the price of fertilizer to potentially increase, the marginal cost to be equal to the price, the average total cost and average variable cost to be equal to the price, the quantity supplied by each firm to decrease, and the total quantity supplied to the market to decrease as some firms exit the market.
a. If the firms in the fertilizer market are currently making economic losses, the price of fertilizer would be below the average total cost and the average variable cost, but it would be equal to the marginal cost of producing fertilizer.
In a perfectly competitive market, firms will continue producing as long as the price they receive is equal to or greater than their marginal cost. If the price is below the average total cost and average variable cost, this means that the firms' costs are higher than the revenue they are generating. However, the firms will still produce as long as the price is equal to or greater than their marginal cost, as it allows them to at least cover their variable costs.
c. In the long run, if there is no change in demand or the firms' cost curves, several adjustments will occur.
First, due to the economic losses, some firms may exit the market. This will decrease the supply and bring the market closer to equilibrium. As the number of firms decreases, the total quantity supplied to the market will also decrease.
Second, the decrease in the number of firms will lead to a decrease in the industry supply, shifting the supply curve to the left. This will result in an increase in the price of fertilizer.
As the price of fertilizer increases, the marginal cost of producing fertilizer for the remaining firms will remain the same, assuming there are no changes in the firms' cost curves. However, the average total cost may decrease if there are economies of scale for the remaining firms as they increase their production levels.
Ultimately, in the long run, the market will reach a new equilibrium with a higher price of fertilizer, a potentially lower average total cost, a decreased quantity supplied by each firm, and a lower total quantity supplied to the market. This adjustment allows the remaining firms to potentially achieve economic profits or, at least, break even.