Question

5) The plywood market is perfectly competitive. The demand for home construction increases, increasing the demand for plywood. If the increase in demand for plywood is permanent, should the managers of a plywood firm increase their firm’s capacity? Why or why not?

Answer 1

At the status quo, the increase in the demand for plywood would mean that there is shortage in the market of plywood. Thi wpuld mean the price will go above the Marginal cost. In competitive equilibrium we have the price rule as Price equals the Marginal cost. Since the price is above marginal cost, there will be profit in the market which would drive in more producers to enter market above that the producers will increase their capacity until the price equals Marginal cost again and the profit are drived down to zero'.