Question

Assume the cookie industry is perfectly competitive and was earning a zero-economic profit until Matt started...

Assume the cookie industry is perfectly competitive and was earning a zero-economic profit until Matt started raving about cookies on the radio which caused the demand for cookies to increase. (3 pts.)

Will this cause the price of cookies to increase or decrease?

Will this cause the profit firms earn from selling cookies to increase or decrease?

Eventually, firms selling cookies will earn a zero-economic profit again. Briefly explain how.

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Homework Answers

Answer #1

(i) When demand for cookies increase, market demand curve shifts rightward. Supply remaining unchanged, this will increase market price of cookies.

(ii) Since demand is higher, in the short run, individual firms' demand will be higher, and cost structure remaining unchanged, firms will start earning positive economic profit. Since firms were earning zero profit earlier, it means firm profit will increase.

(iii) Positive short run profit will attract new entry, and new firms will enter the cookie market since entry is free in perfect competition. As more firms enter, market supply rises, shifting market supply curve rightward and lowering profit. Eventually all firms will earn zero economic profit.

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