HW 2 - Sol

# HW 2 - Sol - ECON 425 100 HOMEWORK#2 SOLUTIONS 1 The...

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E CON 425 - 100 H OMEWORK #2 S OLUTIONS 1) The Hotelling Location Model was used to model product differentiation along the characteristic space. Explain the effect of the following on the equilibrium number of firms if firms are free to enter and exit (monopolistic competition) and on profits of the firms if the number of firms is predetermined (no entry). Case 1: Under free entry and exit (monopolistic competition). That is, firms enter and exit until profits are zero. So first, the firms would be in an equilibrium where their profits = 0. (a) Increase in Fixed Cost (FC) All firms were starting out making zero profits. Now if fixed costs increase they would start making a loss. So firms would start leaving. As firms leave, other firms gain market share and profits increase. And thus, firms will stop leaving when their profits increase back to zero. So if fixed costs increase, the equilibrium under of firms will decrease. (b) Increase in the number of consumers along the mile (L) This will increase the profits, and thus more firms will start entering. (c) Increase transportation costs (c) This will make consumers less willing to buy, so firms profits decrease, so firms will leave. (d) Increase in people’s utility of eating ice-cream (U) People will now will be willing to pay more for the good (ice-cream) and thus since profits have increased, firms will enter as long as there as positive profits from entering. Case 2: If the number of firms is fixed. These effects will just have an effect on the profits. (a) Increase in Fixed Cost (FC) Firms will earn lower profits. (b)

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## This homework help was uploaded on 03/25/2008 for the course ECON 425 taught by Professor Watugala during the Summer '06 term at Texas A&M.

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HW 2 - Sol - ECON 425 100 HOMEWORK#2 SOLUTIONS 1 The...

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