Question

In a monopolistically competitive​ market, the government applies a specific subsidy of​ $1 per unit of output. What happens to the profit of a typical firm in this​ market? Does the number of firms in the market rise or​ fall?  

Assume firms are identical in terms of their cost structure​ (e.g., their cost curves are the​ same).

If a​ $1 per unit government subsidy is​ introduced, then in the short run firm profits will ____________ and in the long run the number of firms will ________ until firms ______________

Answer 1

A subsidy is likely to increase production in monopolistically competitive market. This will increase the profit because the market price received will not change but the cost will reduce. This will increase the profit for the typical firm in the short run. In the long run as more and more forms will enter the market attracted by this profit, the number of firms will increase until each and every firm is earning zero economic profit.

In the short run firms profit will increase, and in the long run number of firms will increase until firms zero economic profit.