Starting off from equilibrium, demonstrate graphically (and write into a table) what happens to P,Q,q, and Profits in the short-run, and long-run, if the interest rate decreases.
Consider the market for wheat. Most farmers have loans (that are used to buy equipment and land) that are based on flexible interest rates (i.e. they change with the market rate). Starting off from equilibrium, demonstrate graphically (and write into a table) what happens to P,Q,q, and Profits in the short-run, and long-run, if the interest rate decreases.
Solved by verified expertShort-run:
In the short run, we assume that firms cannot enter or exit the market, so the number of firms is fixed. The decrease in the interest rate would lower the cost of borrowing for firms, which reduces their costs of production.
Graphically, this shift in cost can be represented as a leftward shift of the marginal cost (MC) curve, as shown below:
image.png
Table:
Before Interest Rate Decrease After Interest Rate Decrease
P Equilibrium Price Lower than before
Q Equilibrium Quantity Higher than befor
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q Quantity per firm Higher than before
Profits Existing firms earn profit Existing firms earn more profit
Long-run:
In the long run, firms have enough time to enter or exit the market. If firms are earning a profit, new firms will enter the market, and if they are making losses, some firms will exit the market. This entry or exit of firms will cause the market supply curve to shift until all firms are earning zero economic profit in the long run.
In the case of a decrease in the interest rate, the lower cost of borrowing will lead to lower costs of production, which will result in an increase in the number of firms entering the market. As more firms enter the market, the market supply curve shifts to the right, causing the equilibrium price to decrease.
Graphically, this shift in the supply curve can be represented as follows:
image-2.png
Table:
Before Interest Rate Decrease After Interest Rate Decrease
P Equilibrium Price Lower than before
Q Equilibrium Quantity Higher than before
q Quantity per firm Unchanged
Profits Existing firms earn profit Zero economic profit in long run
Note: The exact magnitude and speed of the shifts and adjustments depend on the specific characteristics of the market, such as the elasticity of demand, the ease of entry and exit, and the availability of resources, among others.
