If the market demand for a product increases, what will happen to production price and production cost?

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pohnpei397 eNotes educator| Certified Educator

a. Product price will increase and production costs will fall, resulting in greater profits.

b. Product price will decrease and production costs will rise, resulting in greater profits.

c. Product price will decrease and production costs will rise, resulting in lower profits.

d. Product price will increase and production costs will fall, resulting in lower profits.

e. Product price will increase and profits will increase.

The answer to this question is either Option A or Option E, but we do not have enough information to know which of these two is the best answer.  We can be certain that none of the other options can be correct.

First, we can eliminate Options B and C.  When the demand for a product rises, there is no reason for the price of the product to fall (we must assume that all other variables are being held constant).  This means that those options are wrong.  Similarly, we can reject Option D.  If the sale price of a product goes up and the cost of producing it goes down, profits will clearly rise.  This means that Option D cannot be correct.

This leaves us with Options A and E, but we do not have enough information to know which scenario is correct.  As a firm produces more goods or fewer, its marginal costs change.  However, we cannot know whether its marginal costs will go up or down when it produces more goods, as the firm in this scenario is doing.  This depends on where the firm is on the marginal cost curve.  If the firm is already producing at or above its optimal level (the number of goods that result in the lowest possible marginal cost), its marginal costs will increase when it produces more goods.  In this case, Option E might be correct if the price of the product goes up enough to override the increased cost of production  If, by contrast, the firm is producing fewer goods than optimal, its costs will decrease when it produces more.  In this case, Option A will be correct. 

Clearly, either Option A or Option E must be correct, but we cannot know which is the best answer given the amount of information that we have in this question.