The firm's decision to produce is driven by the profitability of the product at given market price. As long as the price is more than the marginal cost of production, the firm will produce and sell butter. But at point where the marginal cost is equal to marginal revenue, the firm will be indifferent and below that, it will stop producing and selling butter as the costs exceed the revenue earned. This is also referred to as profit maximization behavior of firms.
With the establishment of new butter making firms, the supply of butter in the market will increase. Given the demand is not changing, the supply will cause over-supply of butter and thus the price will move to equilibrium level, that is at the intersection of supply and demand curves. This will cause the price of butter to fall until it reaches the equilibrium level.
The overall output levels of production if butter will increase as the supply has increased. For typical firms, the price decrease will cause reduction in their profitability and thus those operating at just marginal margins.
As the new firms have entered the butter making industry, the out put will increase with the increase in the overall output of butter in the market, the firms increase their output levels. Firms which were just breaking even or making less profits may quit as the prices have gone down and their operations may have gone in loss region.
C - Using 2 or more diagrams, explain what will happen...
Firms which were just breaking even or making less profits may quit as the prices have gone down and their operations may have gone in loss region.
C - Using 2 or more diagrams, explain what will happen to the market price and output, AND to the price of a typical firm, if the annual insurance premiums that butter-making firms pay on their buildings increase.
If the annual insurance premium increases for the butter making firms, the total costs will increase because of increase in fixed costs. The increase in costs will cause the firms to reduce their supply until the Marginal revenue is more than the marginal costs.
The reduction in supply will cause the price to move up until it reaches equilibrium level.
The increase in cost will shift the ATC curve for the firms and thus reduce their margins on current price. To be profitable, they must increase the price levels if the firms are going to loss region due to increased costs.
D - Using 2 or more diagrams, explain what will happen to the market price and output, AND to the price of a typical firm, if the price of milk (which is used to make butter) falls.
If the price of milk falls, the cost of production of butter will go down as milk is the major raw material and ingredient of butter. Due to reduction of price of a major raw material, the costs will go down and thus new entrants will start entering the butter production segment. This will cause increase in supply of butter and thus the prices of butter will go down in the short run as well as in the long run. If the demand is held constant at original levels, the prices will go down until equilibrium price level is