Sub: Economics Topic: Micro Economics

Question:

Calculate the output, optimum scale and price while government imposes fixed
fee- show the effects on firm.

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The government imposes a fixed fee per year on each firm operating in a competitive
market. What happens to output, the optimal scale of a firm, and price if there is a free entry
into the market. Show the effects on the firm and industry diagrams.

Solution:

We have perfect competition (PC).

So equilibrium is attained at P=MC where average cost (AC) is minimized. Initially at P1=MC.
But when fixed fee is imposed by the government then AC shifts upwards (from AC1 to AC2).
Firms make loss and few firms therefore start exiting the market. Output of the industry initially
falls and industry supply curve shifts upwards (from S1 to S2) and prices rise.

New firm equilibrium is again attained at P2=MC at the minimum point of AC2. Therefore firm’s
output rises. Supply curve of the industry again shifts from S2 to the right. But industry’s output
may fall, may rise or remain unchanged because on one hand output falls when few firms leave
and also rises when existing firms increase their output. So net effect is ambiguous.

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 Sub: Economics Topic: Micro Economics

** End of the Solution **

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*The Homework solutions from ClassOf1 are intended to help the student understand the approach to solving the problem and not for submitting the same in
lieu of your academic submissions for grades.