Use Figure 12.1 to answer the following question. Assume that this industry is currently enjoying normal economic profit and for whatever reason there is an increase in demand for the goods produced by this industry. Using general equilibrium analysis explain what will happen both in this industry and in industry Y which is perceived by consumers as being a product that is a substitute for product X.

Question

Quizplus · Accepted Answer

The Answer is Initially, demand for X shifts from to This shift pushes the price of X up to creating profits. Demand for Y shifts down from to pushing the price of Y down to and creating losses. Firms have an incentive to leave sector Y and an incentive to enter sector X. Exiting sector Y shifts supply in that industry to raising price and eliminating losses. Entry shifts supply in X to S1 thus reducing and eliminating profits.