Tom\'s Hot Dog Stand has just opened on Main Street in Hometown, NY. Tom\'s is t
ID: 1103104 • Letter: T
Question
Tom's Hot Dog Stand has just opened on Main Street in Hometown, NY.
Tom's is the only such stand in Hometown and he is making a fortune.
Tom's audited income statement reports that he is generating $175,000 in annual profits.
People are beginning to notice his financial success; Tom can't keep his success a secret.
So considering how a free market economy works ... provide a post that will answer the following questions:
1) Will Tom's continue to generate such great profits?
2) What will likely happen to the number of hot dog vendors on Main Street within the next year?
3) What will Tom's have to do to continue earning such high profits?
4) Do you think there will be only one hot dog vendor on Main Street after three years? Why?
Explanation / Answer
In a market model where entry is free, Tom's high level of positive profit will attract new entry. Other hot dog vendor's will enter the market, which will increase the number of hot dog sellers in Hometown. Increased competition from rival sellers will lower the selling price, and simultaneously, market share for each seller will decrease. This will lead to a fall in Tom's profit.
Within next year, it is likely that quite a few hot dog sellers will enter Hometown. In order to compete with them, and still continue earning such high profits, Tom will have to (i) either engage in continuous improvement in production process leading to consistent decrease in average cost, (ii) or differentiate his food product so as to charge higher price from consumers, by making his products inelastic, (iii) or access a critical input exclusive for his use which gives him a natural monopoly power.
However, whichever strategy Tom chooses, with free entry it is likely that his competitors will follow suit and will replicate Tom's strategy over time. Therefore after next 3 years there will be multiple hot dog vendors on Main Street.