Answer the following two questions about perfectly competitive markets: a. There

Question

Answer the following two questions about perfectly competitive markets:
a. There are many taxi drivers in New York City, all of whom sell identical taxi rides. Taxi drivers in New
York are required to hold a special license to operate, and the government only issues 5,000 licenses. Will
these drivers necessarily earn zero prot in the long run, or is it possible for them to earn positive prot?
b. Carlos owns a gas station in Lexington. Carlos estimates his total costs are given by T C = 400 + :01q
2
and his marginal costs are given by MC = :02q. The price of gas is currently $3.75/gallon. Should Carlos
stay in business in the long run? In the short run?

Explanation / Answer

a. rms enter or exit until there is zero prot. Suppose that in the market for NYC
taxi licenses, this would happen when there are 7,500 tax cabs. That there are only 5,000 licenses meanse
that entry is articially halted before the long-run equilibrium number of taxis. While further entry would
shift the market's supply curve to the right, lowering price and thus prot, since this entry is prohibited,
price would stay abot the zero-prot price and prots would stay positive. So, no, it is not necessarily the
case that a competitive market without free entry will converge to zero economic prots.

b . highest prot Carlos can obtain is $48=44 (to nd this, set the price of $3.75 qual to his marginalcost to get Carlos' prot-maximizing quantity, and then calculate prot=revenue - cost from there). Sincehe is losing money, he clearly should shut down in the long run. However, net of his xed costs of $400,Carlos is actually protable, and so there is no reason to shut down in the short run.

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