Suppose that there are 1,000 hot-pretzel stands operating in Toronto. Each stand has the usual U-shaped average total cost curve. Both the market demand curve and the supply curve for pretzels are linear, and the market for pretzels is in long-run competitive equilibrium.

a) Illustrate the current equilibrium in a two-part diagram with the entire market in one part and an individual pretzel stand in the other.
b) Now the city decides to restrict the number of pretzel-stand licences, reducing the number of stands to only 800. Show in a diagram what effect this action will have on the market and on an individual stand that is still operating.
c) Suppose that the city decides to impose an annual lump-sum licence fee on each of the 800 licence holders. Show in a diagram how this fee will affect the number of pretzels sold by an individual stand, and the stand's profit.

a) To illustrate the current equilibrium in a two-part diagram, we can start by drawing a graph with quantity on the x-axis and price on the y-axis. In the market diagram, the demand curve will be downward sloping and the supply curve will be upward sloping. The point where the demand and supply curves intersect is the equilibrium price and quantity in the market.

In the individual stand diagram, we will have the average total cost curve (U-shaped) and the marginal cost curve. The point where the marginal cost curve intersects the average total cost curve is the minimum point of average total cost (equilibrium for the individual stand).

b) If the city decides to restrict the number of pretzel-stand licenses to 800, this will reduce the number of stands operating in the market. In the market diagram, the supply curve will shift leftward, indicating a decrease in supply. The new equilibrium price and quantity will be determined by the intersection of the new supply curve and the demand curve.

In the individual stand diagram, the average total cost curve will remain the same, but the equilibrium quantity of the stand will adjust to the new market equilibrium quantity.

c) If the city imposes an annual lump-sum license fee on each of the 800 license holders, it will affect the individual stand's profit and the number of pretzels sold. In the individual stand diagram, the average total cost curve and the marginal cost curve will remain the same.

However, with the annual license fee, the individual stand's fixed costs will increase. As a result, the average total cost curve will shift upward, indicating higher average total costs for different quantities produced. This will, in turn, decrease the equilibrium quantity of the stand and its profit.

The new equilibrium quantity will be where the marginal cost curve intersects the higher average total cost curve. The profit of the individual stand will decrease due to the higher costs and potentially a decrease in the number of pretzels sold.