Widgets are supplied by a competitive constant-cost industry. On Monday, the ind

Question

Widgets are supplied by a competitive constant-cost industry. On Monday, the industry is in both short-run and long-run equilibrium. On Tuesday, the demand for widgets increases and the industry moves to a new short-run equilibrium. On Wednesday, the industry reaches its new long-run equilibrium.

a) On which day or days is the price of widgets highest? On which day or days is it lowest?

b) On which day or days is the industry-wide quantity of widgets highest? On which day or days is it lowest?

c) On which day or days does Bobo the Widget Man produce the most widgets? On which day or days does he produce the least?

Use graphs to justify your answers.

Explanation / Answer

Competitive constant-cost industry is one which has a horizontal long-run supply curve. The supply curve is horizontal because expansion of the industry causes ni change in production cost.

It is given that the industry is in equilibrium on Monday (long run and short run), that means the market equilibrium is attained at the intersection of short run demand and short run supply curves. On Tuesday, the demand for widgets increases. As the demand increases, the market price of widgets increases and the equilibrium quantity also rises in the short run.

The higher price and larger quantity are met as each existing firm in the industry takes into consideration the demand shock. This higher price induces the other sellers to come into this market and increases the supply of the widgets. The supply will increase to the full extent that is by the full amount of demand shifts. This makes the widgets market the constant-cost industry.

Graph is given below:

This answers all the questions.

Initial equilibrium is at E, the equilibrium price is P0 and quantity is Q0. As demand increases, the demand curve shifts from D0 to D1, and the new equilibrium is at B, the equilibrium price is P1 and quantity is Q1. Due to this demand shock, the supply curve shifts from S0 to S1, the new equilibrium is achieved at C and the equilibrium price is P0 and quantity is Q3. This red line denotes the long run supply curve of the industry.

a) Price of widgets is higher on Tuesday. Price is same for all the remaining days.

b) On Wednesday the industry-wide quantity of widgets is highest. It is lowest on      Monday.

c) Bobo will produce most widgets on Tuesday and least on Monday.

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