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Several years ago, people became concerned about the undesirable health effects of eating margarine
Several years ago, people became concerned about the undesirable health effects of eating margarine. The demand for margarine dropped, decreasing its price. Some time later, the price of margarine started rising steadily, although demand hadn't been changing. After several months of price hikes, the price of margarine reached the price observed before demand decreased. According to a consumer watchdog organization, the rising price of margarine was evidence of a conspiracy on the part of margarine producers. Which of the following provides an alternative explanation for the rising price of margarine and its eventual return to the original price?
A. The decrease in demand was followed by an offsetting increase in supply.
B. As firms exited a decreasing-cost industry, the equilibrium price increased.
C. Demand returned to normal following the health scare.
D. As firms exited a constant-cost industry, the equilibrium price increased.
Expert Solution
Answer: D
The initial price decline from a reduction in demand likely reduced the profits of firms in the industry. This caused many to leave the market which caused the supply curve to shift left. A leftward shift is supply will cause price to rise. Further, this is a constant-cost industry since price reverted back to the same level meaning marginal cost was constant and firms in this competitive market are selling output where price is equal to marginal cost. Since output fell and price remained the same, marginal cost also remained the same.
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