Reference no: EM132334083
Case Study: Competitive Markets
Please address the following case study relating to a milk producer in a perfectly competitive market. This case study relates to Chapter 11 of the textbook. All sections please.
Note: There are videos of hand-worked problems to accompany section 2 and section 3 but not section 1 because the questions in section 1 follow from the reading.
Section 1 - Competitive Market Basics (pages 390 - 395)
a. Pick 2 out of the following three markets. Make a case for perfect competition being an appropriate model for each of those markets:
- Milk
- Commercial real estate
- NYSE (the New York Stock Exchange)
b. Make a graph with the demand curve and the marginal revenue curve for a milk producer in a perfectly competitive market with a market price of $2.00. In 1 or 2 sentences, interpret the marginal revenue curve in your own words.
Section 2 - Competitive Markets in the Short-run (pages 395 - 410, also consider pages 425-433)
For the purposes of this problem, the quantity produced (Q) will be measured in units of 100,000 pounds. Prices and costs will be measured in $thousands. Note that the units do not affect your method of solving the profit-maximization problem as long as the units are consistent. However, you should convert the quantities and prices back to single pounds and dollars at the end.
The wholesale price of milk (p) is 19 ($thousand). As a milk producer, you face various variable, fixed, and sunk costs as follows. The cows cost three thousand dollars per 100,000 pounds of milk produced (C = 3Q). You own the cows but the cows can easily be resold, so the (C = 3Q) is like a wage paid on your investment in the cows. Your workers cost an amount per cow that increases as the size of your herd grows because it becomes more difficult to manage (C = Q + ½Q2). Care for the cows costs one thousand dollars per 100,000 pounds of milk produced (C = Q). You own your land and cannot readily resell it. The mortgage for the land costs 80 thousand dollars (C = 80). You also own outdated machinery used to collect and store the milk that cost 100 thousand dollars when you purchased it, but the machinery cannot be resold or used in any way (so it is a sunk cost).
a. Categorize each of the costs as variable, fixed, or sunk. What is your profit-maximizing output? What are your profits (or losses) in the short-run? Would you shutdown in the short-run? If other firms face the same costs as your farm, do we expect the industry to experience entry or exit?
b. What happens to the profit maximizing output you produce if the rent on the land falls 25% to $60,000? What happens to the profit maximizing output you produce if you had paid $200,000 for your milking machinery? Describe why these results intuitively make sense in this setting.
c. Graph the short-run supply curve for your farm. On a separate graph make a short-run supply curve for the market if it contains 1,000 farms that have the same costs as your farm.
Section 3 - Competitive Markets in the Long-run (pages 410 - 433)
Now let's consider your farm in the long-run. In the long-run, the market price adjusts to 16 ($thousand). Because you have more flexibility in your land, machinery, and labor usage in the long-run, your long-run costs differ from your short-run costs and are described by the function:
C = 36 + 10Q + ¼Q2
a. What is your profit-maximizing output? What are your profits (or losses) in the long-run? Is that what we expect?
b. Graph the demand curve, long run marginal cost, and long-run average cost for your farm.
c. Suppose market demand is Q=40,000-1,000P. What is the equilibrium number of firms?
d. Suppose that the public becomes aware of scientific research indicating that the hormones in milk are dangerous to children which shifts demand to Q = 35,000 - 1,000P. Roughly speaking, what happens to the quantity produced by each farm and the number of farms in the short-run? Roughly speaking, what happens to quantity produced by each farm and the number of farms in the long-run?