Question

Group Questions 7.1

Note that Tulip growing is a “perfectly” competitive industry, and all tulip growers have the same cost curves (or schedule) with the standard U shaped Average Total Cost curve.

The market price of tulip is $15 a bunch, and each grower maximizes profit by producing 1,500 bunches per week.

At the profit maximizing output, the average total cost of producing tulip is $10 a bunch and the average variable cost is $8 a bunch.

Utilizing the cost curve graphs, illustrate what may happen to the economic profit of a tulip grower if the market demand for tulips increases (or shifts to the right)?

How does the number of tulip growers may change in the long run?

What is the economic profit in the long run?

What market price will induce the tulip growers to “shut down” in the short and long-run.

Explain why the tulip growers may in interested in forming a trade group or association and require new growers to be licensed

Answer 1

a. If the market demand for tulips increases or shifts rightwards, then the price in the tulip industry will increase. As the price in the tulip industry will increase, the firms will start earning super normal profits in the short run. As the price increases, the total revenue of the tulip growers will increase and this will increase economic profits of tulip growers.

b. In the long run, the earning of super normal profits by the existing firms will attract other firms in the tulip industry and thus number of firms in the tulip industry will increase in the long run due to entry of new firms in the industry.

c. In the long run, the firms will keep entering the tulip industry until the prices fall to the minimum point of the average cost curve of the firm. Thus, in the long run prices will fall to the level of minimum average cost of production inducing the firms to earn only normal profits in the long run.

d. In the short run, the firm will shut down if the prices fall below the minimum point of average variable cost curve of the firm. In the long run, the firms can adjust their production level and thus will not shut down in the long run.

e. In order to restrict the entry of new firms in the industry driving the prices down to the normal profit level only, tulip growers will form a trade union requiring new growers to be licensed.