Question

Mer of Cana- 1000 hot-pretzel stands operating in muustry? 9. Suppose there are 1000 hot-pretzel stands oper Toronto. Each stand has the usual U-shaped aver total-cost curve. The market demand curve for pret- zels slopes downward, and the market for pretzels is in long-run competitive equilibrium. a. Draw the current equilibrium, using graphs for the entire market and for an individual pretzel stand. b. Now the city decides to restrict the number of pretzel-stand licences, reducing the number of stands to only 800. What effect will this action have on the market and on an individual stand that is still operating? Use graphs to illustrate your answer. c. Suppose that the city decides to charge a licence fee for the 800 licences. How will this affect the number of pretzels sold by an individual stand, and the stand's profit? The city wants to raise as

Answer 1

a.

px XL -- ..-... 1000 MARKET FIRM

b. Due to the restriction ont be number of stands, supply curve shifts left to S2.

This will lead to rise in price and fall in quantity to 800 stands. Now price is greater than Average Total cost, so each firm earns a positive profit. This encourages other firms to enter the market but they cannot due to the restrictions and licensing.

P2 体 P2 AICE px 800.1000 MARKET FIRM

c. The city can charge a license fee. Since it is a lumpsum amount, marginal cost is not affected, so the quantity remains the same. But it leads to rise in average total cost. This reduces the profit earned by individual firm. Each firm will be willing to pay up to their positive economic profit as the license fee. Profit is equal to (P-ATC)Q*. This amount will bring the highest possible revenue.