2005 CAS VEE - Q8

[Dr. John Zoidberg]

Good X is produced in a perfectly comp industry. Long-run equil with 100 firms, each producing 50 units of X/day price 10. Constant-cost industry, usual-shaped cost curves.

Gummint then imposes 50 fee/day

Comparing the new long-run equil vs. the old:

1) Price will rise by less than 1
2) each firm will produce less output
3) Demand will fall by the same percent as the number of firms

a) what does 3 mean?
b) which of the 3 are right (could be multiple answers)

[Gandalf]

What does "Constant-cost industry" mean?

CAS thinks answer is 1 only, doesn't it? I'm not sure why that would be so.

I think 3 means that the new equilibrium will still have each firm producing 50 per day, but that there will be fewer firms. E.g., now we have produced = demand = 100 * 50 = 5000 (must have produced = demand for equilibrium)

#3 is saying that if new demand = 4500 (lower demand since price will be higher), it will be achieved by 90 firms producing 50 rather than by 100 firms producing 45 or some other combination. Thus, demand (5000 to 4500) and firms (100 to 90) each drop 10%. I' m guessing here, but it seems like a reasonable interpretation.

Actually, "1 only" solution seems to hang together. They envision that whatever the new equilibrium demand is, it will be achieved by 100 firms, all producing the same number of units, something less than 50. Maybe.

[Dr. John Zoidberg]

Answer 3 really confuses me, it's so poorly worded. Thanks