Now assume that the cigarette industry is perfectly competitive and that cigarettes are identical. We also assume that there is no cigarette tax. Using Diagram(s) illustrate what will happen if the cigarette producers earn positive economic profits. Also use a diagram(s) to explain the implication to an individual cigarette producer if the government’s anti-smoking campaign process to be successful.
In a perfectly competitive market the determination of prices is through supply and demand. The actions of any one firm or consumer will have no impact on the market price for which, if either are to buy and sell in such a market, they have to accept the market price. Firms in a competitive market are unable to dictate the price for which they sell an item for and over a long period of time will be unable to make an economic profit.
This being said however, in the short term, if there is a positive economic profit, it is possible for firms to enter the market making a profit until there is no economic profit left. Items in a perfectly competitive market are perfectly elastic whereby the demand curve is horizontal. This is indicative of firms being able to sell as large a quantity of an item as they can at the market price but will be unable to sell at a higher cost.
Should the government’s anti-smoking campaign be successful, the demand for cigarettes will go down as consumers will consider the cost too expensive. However, it is quite likely that the supply will stay the same resulting in a surplus of cigarettes. This will negatively affect suppliers and retailers profits in the short term. As this would result in an economic loss for firms, the result would likely see some of these firms exiting the market. This would result in a shift allowing the remaining firms to make a profit again. Therefore, the market will again reach equilibrium and the firms will again be able to break even.
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