Question

Example 2 (Carlton & Perloff, Ch.3 #2) The government imposes a fixed fee per year on each firm that operates in a competitive market. What happens to output, the optimal scale of a firm, and price if there is free entry into the market? What will happen to price, firm output and total output in the long run?

Answer 1

As equilibrium is achieved at P=MC, so this is a type of perfect equilibrium. As govt. imposes a fixed fee, AC1 moves upwards to AC2. Some of the firms may leave the market as some firms incur loss. Consequently, this make the ouput of the industry to fall and this led the industry supply curve to move upwards from S1 to S2 and prise rises as well.

Now, the new equilibrium is going to be P2=MC. he firm's output increases. The industry's output may rise, fall or remain stagnant because if firm leave, output falls, but it can rise if the firms increases their output . From this, we can not say whether the output will going to rise or fall.