vast S VYISIUILILS PLAGUE acUVIEES Unit 1.5.2 Perfect Competition e Practice Activity 1. Onthe axes below, draw graphs for @ perfectly competitive market for apples and an individual farmer in that market. Assume the market is producing at its long-run eequbrium level of output. Explain the situation experience by the individual farmer when the market is in its long-run equilibrium. @ en The market is in equilibrium, meaning there is no reason for fms to enter or exit the market. ‘The individual apple growers are breaking even, covering all their explicit costs (land, labor and capital) and eaming a normal profit for the grower, but no economic profits are being earned. © 2 Trees ctpnrs a cael ett tr pcan dee ital rl tan tm_ywwingl » vISNUUU preacuts aGUVTES e short-run effect of higher pear prices on the market for apples and for a typical apple farmer. Explain The rise in pear prices causes consumers to switch to apples. Demand for apples will increase and in the short-run apple growers will enjoy economic profits as the price rises above their minimum average total cost. @ 3. How will the apple market adjust io the higher prices of pears in the long-run? Show andweine ® YuIMIVIUILS presCUGY ACUVIUES e explain the effect on the market for apples and on an individual apple farmer in the long-run. Mo Explain: In the long-run (in the case of apples, this would be based on the growing season), farmers will allocate more land to apple trees, increasing the supply of apples, causing price to fall and eliminating any economic profits enjoyed by farmers following the rise in pear prices, e 4. Anew technology which increases the productivity with which apples can be harvested is adopted widely across the farming sector. Show and explain the effect this new“weing > vuQuULs prauuue aLUVIUES e technology has on an individual apple farmer and in the apple market in the long-run PI Explain: ‘An individual apple farmer who adopts the new technology will enjoy lower marginal and per Unit costs of production, allowing the farmer to earn short-run economic profits. In the long-run, the new technology and the profits it brings will atract new competition to the market, increasing the supply and driving the price of apples down for consumers, eliminating the economic profits seen above. @ 5, Tariffs on imported tropical fruits are removed, reducing their prices. Show and explainthe effect that a fallin tropical fruit prices will have on the market for apples and the typical apple farmer in the short-run uc Explain: ‘The fall in the price of a substitute causes demand for apples to decrease, driving the market price down. This causes the marginal revenues and demand for a typical apple grower to decrease, forcing him to reduce his output to avoid losses. Despite this, the apple farmer is, now earning economic losses, as the price is below the farm's cost of production 6. Show and explain the effect that lower tropical fru prices will have on the market forvicinal > vuniUVMnas prawuce auUviUES e apples and apple farmers in the long-run. Explain: Inthe long-run, lower tropical fruit prices will make apples less desirable to domestic consumers, so farmers will switch out of growing apples and into more profitable produce. ‘The supply of apples will decrease, causing the price to rise back to the "break-even' level. ‘The losses experienced when the tarif on tropical fruit was removed are eliminated as firms exit the market, The farmers that remain will once again break even e@ T. The state government in California, where only 5% of America’s apples are grown,yygine » vumunaiuius pracuey BcUVIES imposes a very large per-unit tax on apple growers. Assume this increases the growers! ® average variable costs (AVC) above the equilibrium price, Show the effect the state tax will have on a typical California apple farmer in the short-run, Pic OF a Explain: ‘The tax on California farmers causes their costs to rise. However, since only 5% of the Country's apples are grown in California, this has no noticeable impact on the market price. Therefore, the typical Califomia farmer will now experience large losses (the red rectangle), @ _| Melessesexzarenced rom continuing o operate exceed the famers total fred cost (he shaded rectangle). Losses can be minimized by shutting down and losing the money invested in land and capital. In fact, at the market price the farmers cannot cover their average variable costs, meaning they can no longer operate their farms (since they can't even earn enough fo pay their workers). The typical Califomia apple farmer will be force to either shut down or find cther ways to cut his costs to stay in the market 8 How will California growers respond to the state apple tax you illustrated in #7 in the long-run? They will either have to shut down (since the price is below their AVC) or find a way to lower their variable or fixed costs to stay in the market. 9. Explain whether the apple market was achieving allocative efficiency and productive efficiency in the scenarios you illustrated in each ofthe following questions from this activity: 2. Question 2: Allocative efficiency? ‘Yes, because output occurs where supply (marginal cost) equals demand (marginal benef) @ i. Productive effeency?_wwginer > vyIMIJuUua plauiey aGUvIES No, because since farmers are earning economic profits they are not forced to produce at their minimum ATC. This means they are not producing in the “least cost manner” b. Question 5: i. Allocative efficiency? Yes, because output occurs where supply (marginal cost) equals demand (marginal benefit) Ji. Productive efficiency? No, because the farmers are producing below the productively efficient level in order to minimize ther losses. At their MC=MR level of output, the farmers’ ATC is not atts minimum, meaning they are not producing in the *least cost manner” © Question 1 i. Allocative efficiency? Yes, because output occurs where supply (marginal cost) equals demand (marginal benefit) ji, Productive efficiency? ‘Yes, because when a perfectly competitive market is in long-run equitbrium the goods price is equal to the firms’ minimum ATC, forcing them to produce in the “least cost manner’ 10. Explain why producers in perfectly competitive markets are likely to earn only a normal level of profit in the long-run. The existence of any economic profits (profits that are greater than what is considered “normal” for a particular industry) wil attract new competion, increasing the market supply, reducing the price and eliminating any short-run profits that were enjoyed On the other hand, economic losses (or profits that are below what is considered “normat’) will be eliminated as business owners that are sick of losing money will exit the market, reducing market supply, driving price back up to the “break-even level.