7. Price regulation of a natural monopolist Aa Aa Consider the local telephone c

Question

7. Price regulation of a natural monopolist Aa Aa Consider the local telephone company, a natural monopoly. The following graph shows the demand curve for phone services, the company's marginal revenue curve (labeled MR), its marginal cost curve (labeled MC), and its average total cost curve (labeled ATC). You can hover over the points on the graph to see their exact coordinates. PRICE, COST, MR (Dollars per month 100 90 80 70 60 50 40 30 20 10 ATC MR 0 6 12 18 24 30 36 42 48 54 60 QUANTITY (Thousands of households per month) Assume no government regulation. If the natural monopoly provides the profit-maximizing output, it will provide phone services to 40,000 households per month at a price of $20 and earn a profit of $375,000 per month. Suppose that the government forces the monopolist to set the price equal to marginal cost. In the short run, under a marginal-cost pricing regulation, the monopolist will provide phone services to 25,000 households per month at a price of $20

Explanation / Answer

Without regulations, any monopoly will produce according to MR = MC. Hence it provide services to 24000 households and the price is $35. Profit = (35 - 25)*25000 = $250,000 per month

When P = MC,  it provide services to 50000 households and the price is $10.

Here the natural monopolist will be bearing economic losses.

When P = AC,  it provide services to 40000 households and the price is $20. Profit = (20 - 20)*40000 = $0 per month

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