(a) As the question says the market for chocolate cookies is competitive thus, this complies with the market structure of Perfect Competition where there are a large number of buyers and sellers in the market. The basic characteristics of a Perfect Competition Market structure are that there is perfect knowledge on both sides of the market that is buyers and sellers know what the current market price is and thus, it prevents exploitation of the consumers as producers would not be able to charge unfair prices.
This is because each firm produces an insignificant fraction of the total market supply and therefore is unable to affect price, it is for this reason that each firm in perfect competition is known as a price taker. There are no barriers to entry or exit in a perfectly competitive industry and thus, producers can enter or exit the market without any restrictions and thus, without any significant losses. The intersection of demand and supply curves of the industry determines the equilibrium price a typical producer can charge which also become the demand of the firm.
Due to this, the producers cannot exploit the consumers by charging a high price and thus, the price is always at the equilibrium. This is because if the producers charge a higher price, the demand for the product becomes zero, because the consumers can always switch to another producer as the good is homogenous. (Anderton, 2000) Since the Firms in Perfect Competition are Price takers so they both take the current market price, ‘Pe’ as shown in the Graph where the Market Demand and Supply intersects and form the Market equilibrium.
D0 can be assumed as the Total Demand of Chocolate Cookies in the market and S0 can be assumed as the Total Supply of the Chocolate Cookies in the Market. Not for profit Organisations’ (NPOs) Average Cost (ATCn) is higher than the Average Cost of Profit Making Organisations, that is ATCp, because Not for profit organisations’ (NPOs) employ disabled people and their cost is also high because Profit Making Organisation are making use of Capital Intensive technologies thus, more of their production is automated and they employ fewer workers than the NPOs.
Average Cost of the Profit Making Firms (ATCp) is equal to the market Price (Pe) so they are making a “Normal Profit” just because of higher productivity due to which their cost is reduced. A firm makes a Normal Profit when its total Economic Cost, which is Average Cost in other words, is equal to the price firm is charging. In other words it can be said that the firm is making zero economic profit. A firm makes a supernormal profit when its Average Cost (economic cost) is lower than the price it is charging. The NPOs initially in the Short run are making a loss since their Average Cost (ATCn) is greater than the price (Pe) charged.
A profit making firm may also make a supernormal profit but in the short run only, in the long run it can only make a normal profit or a zero economic profit. NPOs will be following a cost minimizing price, marginal cost price. (b)(i) A lump sum tax is a fixed amount that is charged as tax irrespective of a business’s profit, sales revenue or capital. According to Mankiw (2009), A lump sum tax is the most efficient tax possible because the business’s decisions do not alter the tax owed, the tax does not causes any dead weight losses and does not distort any incentives.
Since, there is a fixed amount payable as tax so there is no administrative expense of hiring tax lawyers and accountants. Short run is the time period when at least one inputs in the production process is fixed and the rest are variable. Usually in the short run, the variable input is labour and the fixed input is capital. In the short run, it is assumed that producers can only alter production by changing the variable inputs rather than any fixed inputs. In the short run, existing firms do not exit the market.
When the government imposes a lump sum tax on the profit making corporations in a perfect competition, it disturbs the market structure of Perfect competition. It challenges the basic theory of Perfect Competition which says no barriers to entry and exit to and from the market. There is no government intervention usually in a perfectly competitive industry since it changes the basic characteristics of the Market Structure. However, after the government decides to impose a tax on the profit making firms only then the Market Structure of the Chocolate Cookies Industry does not remains a ure perfect competition, the Industry has close characteristics with Perfect Competition but cannot be categorised under it just because of the tax imposed. In the short run, the lump-sum tax must only affect the Average cost of the Profit Making firms while all other costs and revenue must be constant if all other factors affecting costs/revenue remain constant. Hence, as shown in the Graph above, The Average cost (ATCp0) of a Profit making firm will increase depending on the amount of tax imposed by the government.
In the graph above, the amount of tax has been assumed to be ATCp1-Pe which shows that the firm is making a loss after the ATCp0 shifts to ATCp1. If the market price is less than the Average Variable cost of the profit making firm, that is the firm is operating below its shut down point (Price = Average Variable Cost) then the firm will have to shut down production in the short run until there is a decrease in its average variable cost or an increase in the market price.
But if in case, the market price is greater than Average variable cost but lesser than Average total Cost then the firm must continue production in the short run since it is covering its variable costs for now. (Mankiw, 2007) (ii) Long run is a time period when all the factors/inputs involved in the production process are variable. There are no fixed factors in the long run. In the long run firms can exit and enter the market freely.
The long run is primarily used to analyze production decisions for a firm and is also used to better understand economies of scale, diseconomies of scale, and long-run market supply. In the long run, there must be a lot of changes in the industry and must also affect the firms in many ways. Like most of the Profit making firms which will be operating below the Shut down point (Price < Average Variable Cost) must not have been able to survive and must have exit the market.
That must only shrink the market supply of Chocolate cookies, if all other factors affecting supply remain constant. The shrinking of supply will shift the Market Supply Curve (S0) to the left to the new Market Supply curve (S1) which must lead to an increase in the equilibrium market price of the industry to Pe1. The new market price will result in NPOs making a supernormal, normal profit or at least covering more of its loss in the short run but making a normal profit in the long run, depending on the number of exits from the market which should influence the change in market price.
The graph below shows NPOs making a supernormal profit (Pe1-ATCn). It shows the Profit making firms also making a normal profit (Pe1 = ATCp1). Again, depending on the number of exits from the market and average costs of the firms, the profit of both the firms must vary. Since the NPOs now can make a Supernormal or at least a normal profit in the long run and will also get donations additionally so they must benefit their workers with all that extra profits earned.
Their Disabled workers must earn much more than they were earning before in the short run and before the lump sum tax by the government was imposed. The NPOs may also employ additional workers after earning extra profits. The workers of the Profit making corporation might be worse off in the short run and some workers which will be working in the firms which had to shut down due to higher Average Variable cost than the market price will be fired while others in the long run will be better off comparatively.
It will be unfair for the Profit making firms in a way that they produce better quality cookies as compare to NPOs but still NPOs are better off than the Profit Making Organisations in the long run. The consumers of the industry will be worse off in the long run, since they will have to pay a higher price just due to the lump sum tax imposed by the Government to make the NPOs better off in the long run.
The tax burden of the Profit making organisations will be totally passed on to the consumers in the long run since they will have to pay the whole tax burden on the producers in the form of price. Word Count: 1531 words without referencing References: Heyne, P. , P. J. Boettke and D. L. Prychitko (2009). Economic Way of Thinking (9th Edition). Mankiw, N. G. (2009). Principles of Economics (5th Edition). Parkin, M. (2007). Economics (8th Edition).
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