Ace Monopoly has a widget plant in Eastville that is the sole supplier of widget
ID: 1169106 • Letter: A
Question
Ace Monopoly has a widget plant in Eastville that is the sole supplier of widgets in Eastville, and it has an identical plant in Westville that is the sole supplier in Westville. There is no trade between Eastville and Westville, so the monopoly status of each plant is secure. The Widget Regulatory Administration (WRA) regulates Ace. The following table shows the total costs associated with different levels of output in each (identical) plant, and it also shows the maximum price that can be charged for different quantities of output in each city.
Maximum Price That Can Be Charged
Output
Total Cost
in Eastville
in Westville
4,000
$68, 000
$18.00
$30.00
4,500
74,250
16.50
27.00
5,000
80,000
15.00
24.00
5,500
85,250
13.50
21.00
6,000
90,000
12.00
18.00
6,500
94,250
10.50
15.00
7,000
98,000
9.00
12.00
7,500
101,250
7.50
9.00
8,000
104,000
6.00
6.00
8,500
106,250
4.50
3.00
9,000
108,000
3.00
0.00
The WRA initially takes the view that the price of widgets should be the same in both cities, and that it should be just sufficient to cover Ace’s marginal costs. What would be the price and output of widgets in each city, under this rule?
On what grounds does Ace protest to WRA? Note what Ace’s profits would be.
WRA relents, and allows Ace to set a price in each city equal to its average cots in that city. What will the price and output be in each city? Why has there been a bigger reduction in output in one city than in the other?
How has the rule adopted in c) had created inefficiency in the widget market? In which city is the inefficiency more serious?
Ace has now come to an agreement with WRA such that it is guaranteed not to have economic losses. What would you predict will happen to its cost schedule over time? Is there anything WRA can do to prevent this?
Maximum Price That Can Be Charged
Output
Total Cost
in Eastville
in Westville
4,000
$68, 000
$18.00
$30.00
4,500
74,250
16.50
27.00
5,000
80,000
15.00
24.00
5,500
85,250
13.50
21.00
6,000
90,000
12.00
18.00
6,500
94,250
10.50
15.00
7,000
98,000
9.00
12.00
7,500
101,250
7.50
9.00
8,000
104,000
6.00
6.00
8,500
106,250
4.50
3.00
9,000
108,000
3.00
0.00
Explanation / Answer
Ans a – If the price of widget is to be kept same in both the cities and is to be enough to cover the costs, then the price will be $18.00 as that would result in total revenue of $72000 which would be sufficient enough to cover the cost of $68000.
Ans b – Ace protests to WRA on the grounds of opportunity lost on earning profits by charging the maximum price that can be charged in the city of Westville. Ace’s profit currently with the price of $18 is $4000 in each plant.
Ans c – If WRA restricts Ace to set a price equal to the cost, then for Eastville, it will be $16.5 as at this price the cost is $74250 and the output is 4500 and the average cost comes to $16.5 which is equal to the price set for that city. Similarly, for Westville city the price would be $14.5 at which the output will be 6500 and the cost will be $94250 with an average cost of $14.5 equal to the price. The difference is because the price which is equal to the average cost is different at every level of output for each city.
Ans d – The difference in output level has created inefficiency in the widget market. In the city of Westville the inefficiency is more serious as there is still scope for earning $0.5 on every unit of output without affecting the production and its cost.
Ans e – The cost schedule over the time will go high and result in losses. For preventing this different prices should be charged in different cities.
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