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What is the effect on prices and the number of firms under monopolistic competition if a...

What is the effect on prices and the number of firms under monopolistic competition if a government provides a subsidy that reduces the fixed cost of each firm in the industry?

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Answer #1

If government subsidy is reducing the fixed cost of each firm then it is also decreasing the total cost. there profit will increase for the existing output level which means in the long run when there is easy entry and exit there will be entry of new firms. The number of firms will increase therefore.

Prices will decrease because as the supply is increased consumers are likely to switch to other firms which will decrease the demand of each existing firm. this will increase the price and quantity of each existing firm in the long run.

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