Suppose there are 1,000 hot pretzel stands operating in New York City. Each stand has the usual
U-shaped average-total-cost curve. The market demand curve for pretzels 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. The city decides to restrict the number of pretzel-stand licenses, 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? Draw graphs to illustrate your answer.
c. Suppose that the city decides to charge a fee for the 800 licenses, all of which are quickly sold. How will the size of the fee affect the number of pretzels sold by an individual stand? How will it affect the price of pretzels in the city?
d. The city wants to raise as much revenue as possible, while ensuring that all 800 licenses are sold. How high should the city set the license fee? Show the answer on your graph.
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