Question

Consider a model of increasing returns to scale with symmetric firms. The equation relating price to the number of firms p= c + (1/b*n) and average cost to the number of firms AC = Fn / (S+c).

c- is constant marginal cost

b - is constant term representing the responsiveness of a firm’s sales to its price

n- is the number of firms in industry

F - fixed cost

S- he total sales of the industry (aka market size)

Assuming we start off in pre-trade equilibrium, what happens in the model when the fixed cost F decreases, in terms of number of firms, prices, and average cost? You can answer this question graphically or with algebra. Would you conclude that consumers are better off, worse off, or uncertain

Answer 1

As proved above, a decrease in the fixed cost will increase the number of firms. Equilibrium prices will increase as F and P are directly related.

AC (Average Cost) will also increase as both F and AC are directly related with each other.

So, the consumers are worse-off as they now have to pay higher prices for goods and services sold in the market