Day care is provided by a competitive constant-cost industry at a price of $40 per child per day. The government wants to increase the availability of day care and thus chooses to build and operate 50 new day care centers across the nation.
(i) In the short run, what happens to the price of day care? Does the total amount of day care provided increase in the short run? What happens to the profits of day care centers?
(ii) In the long run, what happens to the size of the day care industry? What happens to the price of day care and the profits of day care centers? Does the total amount of day care provided increase in the long run?
(i) In the short run, the supply of day care increases and the price of day care falls. The equilibrium quantity of day care provided rises. Day care centers earn negative profits because the price has fallen below their break-even price of $40 per child per day.
(ii) In the long run, economic losses cause some firms to exit the day care industry. The price of day care returns to $40 per child per day, and the profits of day care centers return to zero. The total amount of day care provided falls back to its original level, so the government-operated centers add nothing to the industry's output in the long run.
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