Consider a city that has a number of kebab stands operating throughout the downt

Question

Consider a city that has a number of kebab stands operating throughout the downtown area. Suppose that each vendor has a marginal cost of £1.50 per kebab and no fixed cost. Suppose that the maximum number of kebabs that any one vendor can sell is 100 per day.

4.1. If the price of a a kebab is £2, how many kebabs does each vendor want to sell?
4.2. Assuming the market is perfectly competitive, find the long run equilbrium price for a kebab, under the hypothesis that all vendors have identical technologies.
4.3. If each vendor sells exactly 100 kebabs per day and the demand for kebabs from vendors in the city is
Qd=4400-1200P
how many vendors are there in the long run equilibrium?
4.4. Suppose the city decides to regulate the market, by issuing 8 licences (for a total of 8 vendors), while each vendor keeps selling 100 kebabs a day if in operation. What is the most a vendor would be prepared to pay to buy a licence?

Explanation / Answer

4.1 The question sounds like we are assuming perfect competition. That would mean that demand equals price equals marginal revenue. So, if the marginal revenue is always 2 and the marginal cost is always 1.5, then firms will want to produce as much as possible. In this case, that means that each firm produces 100 kebabs.

4.2 The long run price will equal the minimum of average total cost. If we assume a constant marginal cost, that implies a constant ATC. That would imply that the long-term price is $1.5.

4.3 We know that 100V=QS, where V is the number of vendors. Setting supply equal to demand:

4400-1200P=100V

But the long term price is 1.5 So, V=26.

4.4 This implies that the aggregate supply is QS=800

Setting aggregate supply equal to aggregate demand:

4400-1200P=800. This implies P=3. So, each firm would make a profit of $3-$1.5=$1.5 per kebab. So, each firm makes $150 in profits. That means each firm would be willing to pay up to $150 for a license.

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