Suppose that there are 1,000 hot-pretzel stands operating in Toronto. Each stand has the usual U-shaped average total cost curve. Both the market demand curve and the supply curve for pretzels are linear, and the market for pretzels is in long-run competitive equilibrium.
a) Illustrate the current equilibrium in a two-part diagram with the entire market in one part and an individual pretzel stand in the other.
b) Now the city decides to restrict the number of pretzel-stand licences, reducing the number of stands to only 800. Show in a diagram what effect this action will have on the market and on an individual stand that is still operating.
c) Suppose that the city decides to impose an annual lump-sum licence fee on each of the 800 licence holders. Show in a diagram how this fee will affect the number of pretzels sold by an individual stand, and the stand's profit.
d) The city wants to raise as much licence fee revenue as possible and also wants to ensure that 800 pretzel stands remain in the city. Show in a diagram the optimal amount of licence fee.
e) Return to part (c) and suppose that the city imposes a licence fee of, say, $0.10 per pretzel sold, instead of an annual amount. Show in a diagram how this fee will affect the number of pretzels sold by an individual stand, and the market price and quantity.
f) Apart from raising revenues, why might a city government want to regulate an industry such as this?