Question

Suppose that the market for candy canes operates under conditions of perfect competition, that it is initially in long-run equilibrium, and that the price of each candy cane is $0.10. Now suppose that the price of sugar rises, increasing the marginal and average total costs of producing candy canes by $0.05; there are no other changes in production costs. Based on the information given, we can conclude that in the long we will observe: A. neither entry nor exit from the industry. B. firms leaving the industry. C. some firms entering and some firms leaving. D. firms entering the industry.

Answer 1

B. firms leaving the industry.

Explanation:

The market for candy operates under perfect competition. Therefore, free entry and exit of firms will drive profit down to zero and in the long run, we will see all the firms operating at P = LMC. Initially, the firms are in long-run equilibrium so P = LMC, As the MC and AC of production increases, the cost of production will become higher than candy price in the short run.

Thus, many firms will incur losses and exit the market due to free entry and exit. This will again make the profit zero in the long run and the price will be higher than before. The price will stabilize at LMC, which increases by $0,05. So, the final price of candy = $0.15.