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ClassOf1 Output Optimum Scale

ClassOf1 Output Optimum Scale

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

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09/11/2009

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Sub: Economics Topic: Micro Economics
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Question:
Calculate the output, optimum scale and price while government imposes fixedfee- show the effects on firm.
The government imposes a fixed fee per year on each firm operating in a competitivemarket. What happens to output, the optimal scale of a firm, and price if there is a free entryinto 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 initiallyfalls 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 fr
om S2 to the right. But industry’s output
may fall, may rise or remain unchanged because on one hand output falls when few firms leaveand also rises when existing firms increase their output. So net effect is ambiguous.