Our firm has economies of scope in tires and water bottles The market for water bottles is competitive, and in the short run we are producing at P=MC
The demand for tires has increased and as a result we are producing more tires
What happens to our production of water bottles?
The Correct Answer and Explanation is :
In this scenario, where your firm experiences economies of scope in producing tires and water bottles, the increase in tire production due to higher demand will affect your water bottle production. Since the firm is producing both goods together at lower cost (because of economies of scope), an increase in the production of tires may indirectly influence the production of water bottles.
Correct Answer:
The production of water bottles will likely decrease in the short run.
Explanation:
Economies of scope occur when it is cheaper for a firm to produce two (or more) products together than it would be to produce them separately. In your case, the firm produces both tires and water bottles. This allows the firm to share resources, such as labor and machinery, across both products, thus reducing average costs. The key is that the firm is currently producing water bottles at a price equal to marginal cost (P = MC), which suggests that the market for water bottles is competitive and the firm is in a short-run equilibrium.
When the demand for tires increases, the firm will respond by increasing tire production. However, the production of tires and water bottles is not independent. Since there are shared resources, such as labor and machinery, the firm needs to reallocate some of its resources from water bottle production to tire production. This reallocation is necessary because increasing tire production means more resources are being used to make tires, and less can be devoted to water bottle production.
In the short run, the firm is constrained by its capacity and the fixed nature of some resources. So, as tire production increases, the firm must reduce its output of water bottles in order to allocate those resources to tire production. This adjustment happens because the firm is already operating at P = MC for water bottles, meaning any additional resources for water bottles would need to be drawn from those being used to produce tires.
Ultimately, the firm’s total production in both markets will reflect the reallocation of resources to maximize overall profits, with the production of water bottles decreasing as more resources are devoted to tire production.
Let me generate an image that visualizes this situation.
Here is a visual representation of the economic scenario you described. It shows how the increased demand for tires leads to higher tire production, which, due to economies of scope, results in the reallocation of resources from water bottle production. As a result, the production of water bottles decreases in the short run.
Let me know if you need any further clarification!