Question

Assume that electricity production has been done by several regional firms in the U.S. each operating as a pure monopoly.

Explain and graphically illustrate how the electrical monopolist would determine its profit maximizing price and output level. (Label Pm and Qm)
Identify any area of consumer and/or producer surplus for the profit maximizing monopoly.
Identify the deadweight loss for the monopolist.
Now assume the federal government imposes a regulation on the monopoly. Draw a new monopoly graph for part 2.
Show and explain how the regulated electrical monopolist would determine its profit-maximizing price and output level. (Label Pr and Qr)
Identify any area of consumer surplus and/or producer surplus for the profit maximizing monopoly.
Now the federal government decides to deregulate the market for electricity nationwide. Draw a new monopoly graph for part 3.
Show and explain how deregulation will impact price and output in the now perfectly competitive market for electricity production. (Hint: You should use a monopoly graph to show where the perfectly competitor would set price and quantity.) (Label Ppc and Qpc)

Answer 1

Profit Maximizing Monopoly:

As a pure monopoly, the electrical firm has market power, which means it can set its own price and output level. The firm will aim to maximize its profits by producing the quantity of electricity where marginal revenue (MR) equals marginal cost (MC). The price that the firm charges will be determined by the demand curve, which is downward sloping. The profit-maximizing price (Pm) will be higher than the marginal cost (MC) of producing the electricity. The output level (Qm) will be lower than the socially efficient output level, which is where marginal cost equals marginal benefit (MB). This results in a deadweight loss to society, which represents the loss of consumer and producer surplus.

Regulated Monopoly:

If the government regulates the electrical monopoly, it may impose price controls or quantity restrictions that limit the firm's market power. The regulated firm will aim to maximize its profits subject to the regulatory constraints. The profit-maximizing price (Pr) and output level (Qr) will be lower than the unregulated monopoly, but higher than the socially efficient level. This results in a smaller deadweight loss, but still represents a loss to society.

Perfectly Competitive Market:

If the market is deregulated and becomes perfectly competitive, the electrical firms will be price takers, meaning they have no market power. The price will be determined by the intersection of the market demand and supply curves, and the output level will be where the marginal cost equals the market price. The price (Ppc) and output level (Qpc) will be lower than the regulated monopoly and closer to the socially efficient level. There will be no deadweight loss, and the consumer and producer surplus will be maximized.

Profit Maximizing Monopoly:

^

|

Pm | Demand

| Curve

|

|

|

|------------------- MC

| Qm

|

|

Regulated Monopoly:

^

|

Pr | Demand

Regulated Curve

| /

| /

| /

|-----------/--- MC

| Qr

|

Perfectly Competitive Market:

^

|

Ppc | Demand

| Curve

| /

| /

| /

|-----------/--- Supply

| Qpc

|