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 ...Show more