Question

“Strong prices traditionally cause expansion in a perfectly competitive industry, eventually bringing an end to high prices and manufacturers’ prosperity.” Explain the statement using appropriate diagrams

Answer 1

Although high prices cause an industry to expand entry into the industry eventually returns price to the point of minimum average total cost. The industry is originally in long run equilibrium . The industry produces output Q1, where supply curve S intersects demand curve D1, and the price is P1. At this point the typical firm produces output Q1. At this quantity the MC=MR, which for a perfectly competitive firm is equal to the price. Since price equals average total cost at that point, the firm makes zero economic profit.