Suppose that the cost of operating a taxicab is $25,000/year and that a cab in full-time operation will collect $35,000/year in fares.
-Refer to the information above.Suppose that entry into the taxi industry is restricted but medallions (licences)can be bought and sold.If the annual interest rate on savings accounts is 10%,then the equilibrium price of a medallion will be ________ and taxi drivers will earn ________ their opportunity cost.
A) $10,000;more than
B) $10,000;exactly
C) $1000;exactly
D) $100,000;more than
E) $100,000;exactly

Question

Quizplus · Accepted Answer

The equilibrium price of a medallion can be calculated as the present value of the stream of profits (fare revenues minus operating costs) that the medallion will generate, discounted at the given interest rate. The stream of profits is $35,000 - $25,000 = $10,000 per year. Using the formula for the present value of an annuity, we get:

PV = (annual profit)/(interest rate) x [1 - 1/(1+interest rate)^n]

where n is the number of years the medallion is expected to generate profits (assume indefinitely). Plugging in the numbers, we get:

PV = $10,000/0.1 x [1 - 1/(1+0.1)^∞] = $100,000

Therefore, the equilibrium price of a medallion is $100,000. Since this exceeds the cost of operating a taxicab, taxi drivers will earn exactly their opportunity cost, which is the interest rate on savings accounts. The answer is E.

Suppose That the Cost of Operating a Taxicab Is $25,000/year