Assume glassware is produced by firms in a competitive industry, one of which is Gregor's Glassworks.

Question

(i) Suppose a rent increase is imposed on Gregor's Glassworks but not on its competitors. When would the rent increase cause Gregor to exit the industry? Explain.
(ii) Suppose an earthquake destroys most of Gregor's stock but does not affect his competitors. When would the damages cause Gregor to exit the industry? Explain.

Answer 1

(i) The rent increase is a new fixed cost which would raise Gregor's break-even price. The higher break-even price will drive Gregor out of business if he is in a constant-cost industry, because he (like every other glassware firm) was indifferent about remaining in the industry prior to the rent increase. On the other hand, Gregor may or may not exit the industry if it is an increasing-cost industry. If Gregor is particularly efficient at producing glassware, his break-even price may still be low enough after the rent increase to permit him to remain in the industry.
(ii) The earthquake damages are a sunk cost and will not cause Gregor to exit the industry. The damages cannot be avoided no matter what Gregor chooses to do, so they have no effect on his decision to exit the industry.