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effect on average and marginal costs

Earlier this year the rising price of tortillas resulted in major protests in Mexico City combined with a warning from the Mexican central bank that this may fuel rising inflation. In response the President of Mexico announced that the government will be setting a price ceiling on the price of corn. [Corn is the major ingredient in tortillas, and there are millions of poor people in Mexico who survive largely on tortillas and beans. Some Mexicans are said to spend more than a quarter of their daily income on tortillas.] The President of Mexico lashed out saying, "we will not tolerate speculators and monopolists."

The New Your Times correspondent pointed out that many economic analysts have concluded that price of corn in Mexico has been rising because of the spiraling increase in demand for corn in the Unite States for use in the production of ethanol. (See Question B above)

A Mexican small tortilla maker is quoted as saying: "Look, we can't give our product away because we need a profit, and if they raise the cost of corn, there's no other way."

1. Assume that the small storefront tortilla maker quoted above operates in a monopolistically competitive industry that supplies most of the tortillas to the Mexican population. Analyze and explain the short run and long run implications for an individual firm and then for the "industry" as a whole if the price of corn in Mexico is allowed to rise. Go through a complete analysis on the effect of this on the demand for resources by the small tortilla makers, the effect on average and marginal costs, profits, and decisions to remain in production in both the long and short run. Properly labeled graphs that explain and properly illustrate your answer.

Solution Summary

The effect on average and marginal costs is demonstrated.