Question

1. In a monopolistically competitive market, the government applies a specific tax of $1 per unit of output. What happens to the profit of a typical firm in this market? Does the number of firms in the market rise or fall? Why?

2. What is the effect on prices and the number of firms under monopolistic competition if a government provides a subsidy that reduces the fixed cost of each firm in the industry?

3. Under monopolistic competition with identical firms, is it possible for a firm to produce at the minimum of its average cost curve?

4. One of the hottest trends in 2018 was rental scooters. San Francisco capped the number of scooter companies at six. Thus, a market that was going to be monopolistically competitive became, at least in the short run, an oligopoly. What effects does such a barrier to entry create on equilibrium market quantity, price, profits, consumer surplus, and total surplus?

5. An incumbent firm, Firm 1, faces a potential entrant, Firm 2, that has a lower marginal cost. The market inverse demand function is p = 120 - q1 - q2. Firm 1 has a constant marginal cost of $20, while Firm 2’s is $10, and they have no fixed costs.

a. What are the Nash-Cournot equilibrium price, quantities, and profits without government intervention?

b. To block entry, the incumbent appeals to the government to require that the entrant incur extra costs. What happens to the Nash-Cournot equilibrium if the legal requirement causes the marginal cost of the second firm to rise to that of the first firm, $20?

6. Given the demand and cost conditions of Question 5, suppose that the legal intervention imposed by the government leaves the marginal cost unchanged but imposes a fixed cost. What is the minimal fixed cost that will prevent entry?

Answer 1

One question could be answered in one go.

Specific taxes are charged per unit of output. This means that the price the supplier (the firm)receives is going to vary from the price the demander (consumer) pays for the given product orservice.In a monopolistic competitive market, if a specific tax of $1 per unit is applied, the typical firmwill maintain lower profit margins, leading to less firms in the market. While the demand forthe product will not change, consumers will continue to expect the same product at the sameprice. The consumer demand function remains the same, but the firms are paying more; givenfirms are paying $1 more per unit in taxes and no increase in the price of the product, the profitmargin will decrease. The profit of a typical firm will decrease as the firm needs to share itsprofit per unit with the government. Due to lower profit margins, the number of firms in themarket will fall due to low profit