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Cost Curves in Perfectly Competitive Firms

Catfish farming in Louisiana is a perfect competition industry. Hence, consumers of catfish are getting their catfish at the minimum cost per unit of producing catfish, and they are very happy. However, it turns out that farming catfish in ponds is producing substantial pollution run off of foul water into nearby creeks and rivers, as catfish farmers periodically empty their ponds and refresh them. The pollution is causing a substantial decrease in the crayfish catch, increasing their price, and making consumers who favor crayfish very unhappy. Catfish farming can be reduced to the point where the creeks and rivers can absorb the run off from the ponds without hurting the crayfish. This could be accomplished by charging catfish farmers a pollution fee for every gallon of pond water they empty into nearby creeks and rivers. However, there are more catfish consumers than there are crayfish consumers, and there are not enough votes to enact a pollution fee. But restaurant owners in New Orleans carry a lot of weight and they earn an enormous profit from tourists coming to eat crayfish in New Orleans. They finally get the pollution fee enacted.

Explain the adjustment that will take place in the catfish farming industry in Louisiana that will result from the implementation of the pollution fee. Use diagrams with "U" shaped cost curves.

Hint: The number of firms in catfish farming in Louisiana will decrease, and the price of catfish per pound will increase when a new equilibrium is finally reached.

Solution Preview

The marginal cost curve is derived by determining the cost of each additional catfish produced. It is often U-shaped as costs decline until a certain level of production is reached, and then costs increase as space becomes limited. In the short run, perfectly competitive firms maximize their profits by producing at the point where their marginal cost curve intersects the demand curve. The demand ...