3. Bonus (1pt): Suppose there are 3 firms producing electricity. Each firm has t

Question

3. Bonus (1pt): Suppose there are 3 firms producing electricity. Each firm has the same marginal cost function: MCq) 20-qi, where qi is the amount of electricity produced by firm i. We assume no fixed cost, so total cost is: TCAa)-20q-0.5q2. Consumer demand is such that the price, P, consumers will pay (equal to their marginal benefit) for a total quantity Q (where Q qi q2 +q3) is: P(a)MB(a) 40-3Q. So, total consumer benefit from consuming quantity Q is: TB(Q) 40Q- 1.5Q2 a. The socially optimal production maximizes total benefits minus total costs. So, the socially optimal production will be the set of production quantities (q1, q2, q3) that maximizes TB(Q)-(TC1(qTC2(q2)TC(q3)). What is the socially optimal quantity (Q) and how many firms should produce it (i.e., how many of qi, q2, and q3 are greater than zero in socially optimal production)? What is the price? If there was only one producer in this market (i.e. a monopoly) that wanted to maximize its profits (Pa) xa) (TC(qi), where q- Q, how much would this producer choose to produce and what price would they charge? In the real world, electricity distribution is typically a natural monopoly, and governments have three options for dealing with this: (i) force competition to occur (i.e. require that there be multiple producers), (ii) allow monopoly but tightly regulate prices, or (ii) get out of the way and let the market sort itself out. Based on your answers to a and b above, explain in words (2-3 sentences max.) which of the above three options you think is likely to be the most economically efficient. b. c.

Explanation / Answer

Marginal analysis involves a cost-versus-benefits comparison of various business activities. In marginal analysis, the cost of an activity is measured against incremental changes in volume to determine how the overall change in cost will affect the bottom line of a business. Marginal analysis can show the cost of additional production by a business all the way up to the break-even point. This is generally the maximum cost that a business can sustain without losing money.

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