Question

1. (25pts) Street food vendors in NY City must be licensed. A license allowing you to operate a cart (for example, a traditional hot dog stand) is roughly $300,000. Since different carts sell slightly different products, at different locations, we can safely assume that each cart enjoys some degree of market power and that the street-food market is an example of monopolistic competition. Use the model developed in class to answer the following questions.

(a) (10pts) Each cart operator must pay a fixed cost F, which includes the cost of the cart and the cost of the license, and then can provide meals at a constant marginal cost c. Construct a diagram to show how cost structure and pricing under market power jointly determine (i) the price of street food, and (ii) the number of carts/varieties operating in the city. Label your axes and curves!

(b) (15pts) Use a copy of your diagram above to study what happens when City Hall decreases the cost of the license required to operate a cart. What happens to the price? The number of carts in the city? What does this imply for consumers’ welfare?

Answer 1

Answer (a) The Market under a monopolistic competition is under the equilibrium of market demand and market supply meeting each other at an optimal level. When this optimal equilibrium is nurtured, and the market forces are controlled, the economic status of a society shows an upward rising trend in the longer run. However, the control of the market under a monopolistic competition is tough to manage from the outside. The market forces take care of themselves and operate in their own definite sphere. When each cart operates after paying a fixed cost, including the cost of the license and that of the cart, and provides meals at a constant marginal cost, the cost structure and pricing under market power is jointly determined by the demand and supply forces. Since the firms operate under a monopolistic competitive market, the prices set by the firms would not vary too much in range. The prices would be near to each other and a standard price factor would form the basis of their price variance. In this case of monopolistic market, the pure form of price variance would depend on the quality of the price being rendered by the cart owners, and their customer management skills. In a pure monopolistic market, as shown above, the profit of the firms( In this case , the Cart owners) would depend on their market management skills.

Answer (b) When the City Hall decreases their cost of license required to operate the cart, this would directly impact the cost of operation of the Cart owners. With the price of the license decreasing, the owners would now be able to decrease their marginal cost of the products, thereby reducing the cost of production of one additional unit of the product. This will enable the owners to put in a flexible market price, however, in a monopolistic competition, the price of the product may also depend on the other market factors like the price set by the other firms, or carts. In such a scenario, the owners would make extra marginal profit for each product. The price of the product may either reduce (only when all the Cart owners or majority of the owners decide to pass on the benefit of the license price deduction to the consumers ) , however, if the cart owners, or majority of the Cart owners decide to keep the price stagnant, in that case, the price of the product would remain the same thereby giving the owners extra profit. The number of Carts in the city may considerably rise up due to two factors, primarily, the license cost getting reduced, and secondary being the factor of monopolistic competition, where the entry and exit of firms is absolutely free. In the longer run, the consumer will get the benefit of the reduction in the license prices as in the longer the run, with the gradual increase of the number of firms, there is bound to be a competition among the firms to sell more products , and this will bring the benefit of the reduction in the license cost to the consumers pocket.