Reply Tue 8 Jul, 2014 04:10 am
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Imagine a country where bus and train trips between two main cities are both provided by private companies, and, from a consumer perspective these services are viewed as substitutes. The demand for bus trips is:

(1) D1 = 2000 - 300p1+50P2 +2Y

Where D1 is annual demand for bus trips, P1 is price of bus trips, P2 is price of train trips and Y is average annual income. Assume the supply of bus trips by the industry can be described by:

(2) s1 = 200p1

Where S1 is bus trips per year and the market clears so:

(3) s1 = D1

Assume average annual income, Y, is $75,000 and the price of train trips is P2 = $300. Further, assume the market always clears, there are no empty buses or theft of rides and producers are competitive. Ignore externalities such as anti-social behaviour and pollution.

Part 1

What is the equilibrium price of bus trips?
How many bus trips are provided and purchased?
Calculate the producer surplus for the bus trips providers (bus companies).

Part 2

Assume the government puts a $100 tax on each bus trip which is levied on trip providers. Answer the following questions:

What is new equilibrium price of bus trips to consumers?
What is the new equilibrium price of bus trips to producers?
How many bus trips are produced and sold?
How much tax revenue is raised?

Part 3

The government decided not to apply the tax, but a large bus company who can dominate the market starts to provide bus trips. Its supply curve (called marginal cost curve) for bus trips is:


What price will bus trips now trade at with the new supplier in the market?
How many bus trips will now be provided by the bus companies operating before the large company entered the market?
How many bus trips will now be produced in total?

Part 4

Explain how this type of market structure with one very large firm, capable of influencing prices, and a periphery of small price-taking firms could lead to some sort of price-leadership in the market. How would this affect the welfare of consumers?
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