Question

The graph above shows the cost and revenue curves for a natural monopoly that provides electrical power to the town of Fanaland. If unregulated, the monopolist operates to maximize its profit. (a) Identify the monopolist's profit-maximizing quantity and price. (b) Assume the town government of Fanaland regulates the monopolist's price to achieve the allocatively efficient quantity. What price would the government set in order to achieve the allocatively efficient quantity? (c) Will producing the allocatively efficient quantity be economically feasible for the monopolist? Explain. (d) Suppose instead the town government wants to regulate the monopolist to earn zero economic profit. What price would the government set to have the monopolist earn zero economic profit? (e) Based on your answer to part (d), will the deadweight loss increase, decrease, or stay the same as that of the unregulated monopolist? Explain.

Answer 1

(a) The monopolist's profit-maximizing quantity is approximately 10 units, and the corresponding price is around $45. (b) To achieve allocatively efficient quantity, the government would set a price of $30. (c) Producing the allocatively efficient quantity would not be economically feasible for the monopolist, as the price set by the government is below the monopolist's average total cost. (d) To earn zero economic profit, the government would set a price of $35. (e) The deadweight loss will decrease compared to that of the unregulated monopolist, as the price is closer to the marginal cost, reducing inefficiencies.

Step-by-step explanation:

(a) To find the profit-maximizing quantity, we look for the quantity at which marginal cost (MC) equals marginal revenue (MR). From the graph, this occurs at approximately 10 units, with a corresponding price of around $45. (b) Allocative efficiency occurs where price equals marginal cost. The graph indicates that this quantity is around 20 units, and at this quantity, the government would set a price of $30.

(c) Producing the allocatively efficient quantity is not economically feasible for the monopolist because the price of $30 is below the monopolist's average total cost at that quantity, resulting in a loss for the monopolist.

(d) To have the monopolist earn zero economic profit, the government would set the price equal to the monopolist's average total cost at the profit-maximizing quantity, which is $35. (e) Compared to the unregulated monopolist, the deadweight loss decreases when the government sets a price of $35, as it is closer to the allocatively efficient quantity, reducing market inefficiencies and increasing overall economic welfare.

Answer 2

In the scenario of a natural monopoly in Fanaland, the profit-maximizing outcome is a quantity of 4 and a price of 9.3. Allocative efficiency would not be feasible as it results in losses for the monopolist. Regulatory intervention aiming for zero economic profit would result in a price of 6.5 for a quantity of 6, reducing deadweight loss compared to the unregulated monopoly.

Step-by-step explanation:

Understanding the Regulation of a Natural Monopoly:

When dealing with a natural monopoly like the one providing electrical power to the town of Fanaland, different regulatory approaches can lead to various outcomes in terms of quantity produced and price charged.

(a) The monopolist's profit-maximizing quantity and price occur where marginal revenue (MR) equals marginal costs (MC). In this scenario, the natural monopoly will produce at point A, with a quantity of 4 and a price of 9.3.

(b) For the town government of Fanaland to achieve the allocatively efficient quantity, the price would have to be set where MC crosses the demand curve (point C). This would result in a quantity of 8 and a price of 3.5. However, this price would not cover the monopolist's average costs, leading to losses.

(c) Producing the allocatively efficient quantity would not be economically feasible for the monopolist because it would result in operating at a loss. The price of 3.5 is below the average cost, which is unsustainable for the monopolist in the long run.

(d) If the town government wishes for the monopolist to earn zero economic profit, they would set the price to equal average total costs. The likely regulatory choice is point F, where the monopolist produces a quantity of 6 and charges a price of 6.5, allowing the firm to break even.

(e) Regulating the monopolist to earn zero economic profit (point F) would likely result in a decrease in deadweight loss compared to the unregulated situation. This is because more quantity is produced at a lower price than at the profit-maximizing point A, which could lead to a reduction in inefficiencies commonly associated with monopoly pricing.