Tourist Trap Model with Downward-Sloping Demand Curve

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ECON0402 - Term paper Tourist Trap Model with Downward-Sloping Demand Curve 2010 97 0203 Introduction This paper will attempt to relax the unitary demand assumption of the tourist trap model that we saw in class. The others assumptions are conserved. We will now have a linear downward-sloping demand-curve: p=G-gq I will first discuss what could be the equilibrium price and how we can deduce it. Then, I will explain the conditions that must be fulfill to sustain this equilibrium. Finally, I’ll discuss the economic interpretation of these conditions. Equilibrium price Since we now consider a downward sloping demand curve, the quantity the consumer will buy could be more than 1 and will depends on the price. Therefore, a…show more content…
The profits functions are plotted in figure 2. We also see that the sustainability of the equilibrium at the monopolistic price is positively related to the search cost. Figure 2 : Profit as a function of c, n = 2 and others parameters are the same as in the previous graph. We therefore conclude that the equilibrium at the monopolistic price is sustainable only for high enough n and c. Economic interpretation of the condition We saw that two conditions must hold to ensure the existence of single price equilibrium at the monopolistic price level: * n>n ' * c>c ' We will analyze here the economic intuition behind these two conditions. Number of firm The first one tells us that it requires a large enough number of firms to ensure a price as high as the monopolistic price in every shop. That could be contradictory since the usual intuition is that the more firms we have (that is n -> ∞ ), the more close we get to the perfect competition’s efficient price level. But here we have imperfect information represented by the search cost c. In that case, a higher number of firms implies that the probability to find a low-price shop among all the shops (1n-1) decreases. More specifically if we consider this equation: fpm>1n-1(fp '-c) We can see it as the comparison of the

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