Question: Assume that the taxi industry in Ithaca satisfies the following set of assumptions:

• The industry is perfectly competitive.

• The industry is presently in long-run equilibrium.

• The industry is a constant-cost industry, that is to say, the industry long run supply curve is horizontal at the long run equilibrium price.

• Each taxi driver has a set of "typically" shaped cost curves. In particular this means that short-run supply curve for the individual taxi driver and the industry is typically shaped (due possibly to "dilly-dallying" on the part of taxi drivers).

• All taxi drivers are the identical with respect to their cost structures.

• Demand for taxi rides is typically shaped.

a. Graph the present long-run equilibrium situation for both a typical taxi driver and the entire taxi industry.

Suppose now that the mayor decides to license taxi drivers and issues a limited number of licenses, less than the number of taxis currently in operation. The licenses are freely given to existing taxi drivers on a random basis. For example they put names into a hat and draw out the lucky drivers to decide who will, and who will not, be given a license. Assume that you must have a license to operate a taxi and the government does not collect a fee for the license. HINT: THE TOTAL NUMBER OF “TAXI-FIRMS” WILL NOW BE LESS.

b. Explain and indicate on the graphs for the previous part what will happen to price, quantity, and profit in the short-run and long-run once the licenses have been issued. Be sure to discuss and graphically point out both the effect on the individual taxi driver and the entire taxi market.

c. If any taxi driver with a license can sell the license to an ex-taxi driver who did not get a license, what will be the maximum amount the ex-taxi driver will be willing to pay for the license? (I’m not looking for an exact number.)

d. What would happen to Ithaca's taxi market if someone purchased all the taxi licenses at once? Would it make sense for someone purchasing all the licenses at once to be willing to pay more than the total number of licenses times your answer to part (c) of this question? Explain