Question

Suppose the market for fresh pork is a competitive market. Initially, it is operating at its long-run competitive equilibrium at a market price of $50. Owing to the spread of COVID-19, many people turn to buying frozen meat once a week rather than fresh pork every day. As a result, the market price of fresh pork reduces to $30.

a. With the aid of a pair of market-and-firm diagrams, illustrate how this would affect the equilibrium price and quantity in the fresh pork market and the output of a typical butcher of fresh pork in the short-run.

b. Suppose, for the situation in (a), the average cost of a typical butcher of fresh pork is $40, which includes $15 on buying meat from suppliers, $12 on paying rent, $8 on paying hourly wages on staff, and $5 on other costs. Explain whether a typical butcher should shut down in the short run.

Answer 1

a.

a. As we see in the graph, due to fall in demand, the market demand curve shifts to the left, from D1 to D2. The price falls to $30, Equilibrium quantity falls to Q2. The butcher's ATC is above price when price = $50. So he is making profits. But when price falls to $30, he is charging price lower than ATC. But still his price is above AVC.

b. Butcher's average cost = $40. His average fixed cost = $12 (rent). Average variable cost = $28 (meat+wages+other costs). When price = $30, he is covering his cost of production. So he can continue to produce. He is still making a profit of $2 per unit. It is not time yet to shut down.