Question

Q

Forever 21 has closed all stores in Hong Kong due to fierce competition in the clothing retailing industry.

c)In the long-run equilibrium of the clothing industry, what happens to i)the economic profit of all existing firms; and ii) the price?

d)Draw a new diagram and indicate the“consumer surplus”derived from the purchase of the clothing industry on the new diagram.

e)Define “the deadweight loss”.Also, show the deadweight loss relative to the efficient level of output in the above new diagram.

Answer 1

c) In the long run because of short run economic losses, firms like Forever 21 will leave the market, reducing the number of firms and increasing the demand for existing firms as consumers will switch to them. This would raise the market price as the demand curve D1 will be tangent to ATC. This indicates that in the long run there will be no economic profit / loss for existing firms

d) Consumer surplus is the area of the region between demand curve and price line. It is shown below

e) DWL is the loss in consumer surplus and / or producer surplus due to inefficient price and output combination. In the market, DWL is the area between efficient output (where P = MC) and inefficient output (where P > MC = MR).