8. Price regulation of a natural monopolist Consider the local cable companny, a

Question

8. Price regulation of a natural monopolist Consider the local cable companny, a natural monopoly. The following graph shows the demand curve for cable services, the company's marginal revenue cuve(labeled MR), its marginal cost curvE (abeled MC), and its average total cost curve (labeled ATC). You can hover over the points an the graph to see their eract coordinates. PRICE, COST, HR IDallars per mant 012 4 3D34 47 5 QUANTITY Thaunards of ha.seholds per manth Assume no government regulation. I the natural monapaly provides the profit-maximizing output, it will pravide cable sevices to per month O0 househalds per manth at a price of and earn a profnt of Suppose that the government fortes the monopolist to set the price equal to marginal cost. In the short run, under a marginal-cost pricing regulation, the monopolist will provide cable services to a price od households per month at Even though the government wants to eliminate inefficiency, forcing a natural monapoly to set its price equal to marginal cast results in the natural monepolist depending en government subsicies to operate. Why is this the case? O The natural monopaly runs at an economic loss. O The natural monopoly makes zero profit O The natural monopoly makes a profit,but not as much as when it restricts its output. Suppose that the government fortes the natural monopoly to set its price equal to average cost. Under an average-cost pricing policy, the monopolist would provide cable services to price af households per month at a and eam a proit af per month.

Explanation / Answer

Consider the given problem here under no government regulation the natural monopoly provides the profit-maximizing output by the “MR=MC” condition.

=> The profit maximizing cable services is “25,000” households per month at a price of “35” and earn a profit of “(35-25)*25,000 = 10*25,000 = $250,000, here “ATC=$25, P=$35 and Q=25,000.

Suppose that the government forces the monopolist to set the price equal to MC. In the SR under a MC pricing regulation, the monopolist will provide cable services to “50,000” households per month at a price of “10”. (by using the condition P=MC, here P=10=MC and Q=50,000).

Even though the government wants to eliminate inefficiency, forcing a natural monopolist to set its price equal to MC results in the natural monopolist depending on government subsidies to operate.

“Here the monopolist make a negative economic profit” as the P=10 totally below the ATC, => at Q=50,000 the monopolist is making a loss. which => "1" is the correct option.

Suppose that the government forces the natural monopolist to set its “P” equal to “AC”,. So, under an AC pricing policy, the monopolist would provide cable services to “40,000” households per month at a “P” of “20” and earn a profit of “0” per month, => normal profit.

(Here under AC pricing policy the “P” and “Q” will be determined by the condition P=ATC.).

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