Q.5.1
Suppose the poultry industry in country X is perfectly competitive with the supply of
chicken coming from both domestic farms and farms located in the neighbouring country
Y. The industry is greatly disturbed by the threat of bird flu which is a deadly disease
spreading among chickens.
a)
Suppose the threat of bird flu reduces consumers’ demand for chickens. Explain how the
market equilibrium price and quantity are affected in the short run assuming other things
being equal.
As the threat of bird flu reduces consumers’ demand for chickens, the market demand
curve will shift from D0 to D1, and therefore, the market equilibrium price and quantity
will decrease from P0 to P1 and Q0 to Q1 respectively in the short run.
b)
Suppose the government of country X forbids the import of chickens from country Y to
prevent the spreading of bird flu. Explain how the output level of a typical domestic farm
is affected in the short run assuming that there is no change in the demand for chickens.
Since the government of country X forbids imported chickens from country Y, the
market supply of chickens will decrease from S0 to S1, and therefore, the market
equilibrium price will increase from P0 to P1 while market equilibrium quantity will
decrease from Q0 to Q1. As the market price increases, the marginal revenue of a typical
domestic farm will increase from MR0 to MR1. To maximize its profit, a typical domestic
farm will increase its output level from Q0 to Q1.
c)
Suppose the government of country X requires both domestic farms and farms in country
Y to install new facilities to raise their hygiene standard, which will increase the farms’
average cost but has no effect on the marginal cost. Explain how the market Pe, market
Qe, and output level of a typical domestic farm are affected in the long run assuming that
there is no change in the demand for chickens.
When the government of country X requires the farms to install new facilities, the
long run average cost of a typical domestic farm will increase from LRAC0 to LRAC1.
Since the new LRAC1 is higher than the marginal revenue (MR0), firms face economic
loss and some of the firms, therefore, leave the poultry industry. In this connection, the
market supply of chickens will decrease from S0 to S1, and the market equilibrium price
will increase from P0 to P1 while the market equilibrium quantity will decrease from Q0
to Q1. As the market price increases, the marginal revenue of a typical domestic farm will
increase from MR0 to MR1, and each farm will increase its output level from Q0 to Q1 at
which marginal revenue equals marginal cost, also equals to long run average cost, so as
to earn normal profit.