Widgets are sold by a constant-cost industry where each firm has fixed costs of

Question

Widgets are sold by a constant-cost industry where each firm has fixed costs of $60 and each firm has the following marginal cost curve: Quantites (widgets): 1,2,3,4,5,6. Corresponding MC ($): 10 20 30 40 50

In long run equilibrium, what is the price of a widget? The city would like the price of widgets to change. Plan A is to give each firm a fixed subsidy each year; Plan B is to give each firm an excise subsidy (that is, a subsidy per widget). b) Which plan is more effective in the short run? c) If the city wants the long run price of a widget to be $20, what is the amount of the per-firm subsidy it must offer under Plan A? d) If the city wants the long run price of a widget to be $20, what is the amount of the per-widget excise subsidy it must offer Plan B? e) If the city wants the long run price of a widget to be $20, which plan is more expensive?

Explanation / Answer

a) Fixed Cost = $60

MC per unit = $10

In long run equilibrium price = $70 (60+10)

b) In the short run, excise subsidy is more useful because firm needs to cover only variable cost.

c) It needs ot offer a fixed subsidy of $60 so that fixed cost is eliminated whatever output is produced.

d) It needs to offer $50 (70-20)

e) If the city wants long run price of a widget ot be $20, plan a is more expensive.

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