In large cities, taxi fares are often set above the market equilibrium rate. Som
ID: 1251324 • Letter: I
Question
In large cities, taxi fares are often set above the market equilibrium rate. Sometimes the number or licenses are limited in order to maintain the above-market price. Other times licenses are automatically granted to anyone wanting to operate a taxi. When taxi fares are set above market equilibrium, compare and contrast resource allocation under the restricted license system and the freedom entry system. In which case will it be easier for customers to get a taxi? In which case will the amount of capital required to enter the taxi business be greater?Explanation / Answer
"When taxi fares are set above market equilibrium, compare and contrast resource allocation under the restricted license system and the freedom entry system." This is essentially a labor cartel. Drivers gain market power, which allows them to price above marginal cost and reduce quantity. "In which case will it be easier for customers to get a taxi?" It will be easier to get a cab when the licenses are free because free licenses do not pose much of a barrier to entry. "In which case will the amount of capital required to enter the taxi business be greater?" The capital requirement will be higher when drivers must buy a taxi license. The cost of the license is the capital requirement.
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