The following diagram shows the monthly demand for hot dogs in a large city. The marginal cost (and average cost) is a constant $2 per hot dog.
a. If the market for hot dogs is perfectly competitive, how many hot dogs will be sold per month, and at what price? Suppose there are 100 identical firms in this perfectly competitive market. How many hot dogs is each firm selling, and what are the profits for each firm?
b. Suppose the market was almost perfectly competitive, so that each firm has some very limited ability to change the price. What would happen if one of the firms in this market reduced its output by one-fifth, and no other firm changed its output? What would happen to the price of a hot dog? How much profit would the firm earn as a result?
c. Discuss the ability of one firm to reduce output and raise the market price if the market for hot dogs was instead an oligopoly made up of four firms, each initially producing 25,000 hot dogs per month. If only one firm reduced its output by a fifth, what would happen to the price of a hot dog? How much profit could this firm potentially earn?
d. Compare your answers for parts b and c. What does this tell you about the ability to earn profits in perfect competition vs. oligopoly?