Question

Suppose all firms in a perfectly competitive and zero-fixed-cost industry previously in its long-run equilibrium are now receiving an upfront subsidy from the US government. Please use a graphic tool to answer the following questions: a) How do the MC and AC curve change due to this government intervention? b) At the current price, are the existing firms earn positive, negative, or zero profit? Identify the size of the profit/loss in the graph. c) Will we observe entry or exit in this industry as time goes by? d) What happens to the market price as the industry goes back to a long-run equilibrium? e) By how much each firm and the entire industry are producing in the long run? f) Draw the new long run industry supply curve in your graph. g) How do you think will the social welfare change?

Answer 1

Answer A:-The marginal cost will not be affected by the upfront subsidy but upfront subsidy will result in a downward shift in the average cost to AC2.

Answer B:- Each firm will be earning the positive profit at the current price level P1 as the Ac is less than the price. The profit is represented by the shaded area.

Answer c:- having some possibilities of profit, there will be some new entrants with the time

Answer D;- In the new LREQ, the price will go down where MC and AC2 meet each other which is at P2.

Answer E:- The firm is producing the output equal to q2 while the industry is producing the output t the level of Q2.

Answer F:- the dotted horizontal straight line LREQ2 in the right portion represents the curve.

Answer G:- As p=AC, the value of PS will be zero in long run. But the consumers will be benefited by having the greater output. But the consumer gains can be offset by the subsidy collected from various resources.

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