Consider a monopolistically competitive industry. A graph of demand and cost conditions for a typical firm is depicted in the diagram below.
a. Is this firm generating producer surplus? Is this firm earning a profit? How can you reconcile your answers?
b. Do you expect any entry into or exit from this industry to occur? Explain.
c. Suppose that the government reduces annual licensing fees, causing the fixed cost of the typical firm to fall. Make appropriate shifts of all curves that might be affected. What happens to producer surplus? What happens to profit? Do you expect the fall in fixed costs to cause entry into or exit from this industry? Explain.
d. Shift the demand and marginal revenue curves to reflect the entry/exit you indicated in (c). Find the new equilibrium.
e. Continue to reduce fixed cost. What happens to the demand curve as fixed cost continues to fall? What happens to producer surplus and profit?
f. Find the equilibrium as fixed cost falls to zero.