We continue our study of the garden-gnome industry. Suppose that initially everything was as described in the previous problem. To the complete surprise of everyone in the industry, on January 1, 2001, the invention of a new kind of plaster was announced. This new plaster made it possible to produce garden gnomes using the same molds, but it reduced the cost of the plaster and labor needed to produce a gnome from $7 to $5 per gnome. Assume that consumers’ demand function for gnomes in 2001 was not changed by this news. The announcement came early enough in the day for everybody to change his order for gnome molds to be delivered on January 1, 2002, but of course, but the total number of molds available to be used in 2001 was just the 28 molds that had been ordered the previous year. The manufacturer of garden gnome molds contracted to sell them for $1,000 when they were ordered, so it can’t change the price it charges on delivery.
(a) On the graph below, draw the short run industry supply curve and teh demand curve for garden gnomes that applies in the year 2001, after the discovery of the new plaster is announced.
(b) In 2001, what is the short run equilibrium total output of garden gnomes, ______. and what is the short run equilibrium price of garden gnomes? ______. Look at the intersection of the supply and demand curves you just drew. Cousin Zwerg bought a gnome mold that was delivered on January 1, 2001, and, as had been agreed, he paid $1,000 for it on that day. On January 1, 2002, when he sold the gnomes he had made during the year and when he paid the workers and the suppliers of plaster, he received a net cash flow of ______. Did he make more than a 10% rate of return on his investment in the gnome mold? ______. What rate of return did he make? ______.
(c) Zwerg’s neighbor, Munchkin, also makes garden gnomes, and he has a gnome mold that is to be delivered on January 1, 2001. On this day, Zwerg, who is looking for a way to invest some more money, is considering buying Munchkin’s new mold from Munchkin and installing it in his own plant. If Munchkin keeps his mold, he will get a net cash flow of ______ in one year. If the interest rate that Munchkin faces, both for borrowing and lending is 10%, then should he be willing to sell his mold for $1,000? ______. What is the lowest price that he would be willing to sell it for? ______. If the best rate of return that Zwerg can make on alternative investments of additional funds is 10%, what is the most that Zwerg would be willing to pay for Munchkin’s new mold? ______.
(d) What do you think will happen to the number of garden gnomes ordered for delivery on January 1, 2002? Will it be larger, smaller, or the same as the number ordered the previous year? ______. After the passage of sufficient time, the industry will reach a new long-run equilibrium. What will be the new equilibrium price of gnomes? ______.