Governments may choose t regulate prices charged by natural monopoly firms. Cons
ID: 1227816 • Letter: G
Question
Governments may choose t regulate prices charged by natural monopoly firms. Consider the case in which there is only one water company in a city. In the diagram shown below, the market demand for water that the company faces is D and the corresponding marginal revenue curve is MR. The company's long-run average and marginal cost curves are given by LAC and LMC, respectively. a) If the water company is left to itself with no government regulation, what price and output would result when the firm is seeking profit maximization? Price; Quantity b) If the local government decides to regulate the behavior of the company by using the average-cost-pricing policy, what price and output would result? Price; Quantity c) What are problems with the average-cost-pricing policy? d) If the marginal-cost-pricing policy is implemented, what price and output would result? Price; Quantity e) What are problems with the marginal-cost-pricing policy?Explanation / Answer
A. Profit maximising level of output is where the marginal cost equals the marginal revenue.
The corresponding point on the demand curve determines the price.
Thus output = Q1 and price = $P1.
B. The point where the AC insects the demand curve d steeliness the price and output.
Price = P2 and output = Q2.
C. Charging a price equal to the the average cost would imply earning zero profits. There'll be no economic profit for the firm.
D. The point where the marginal cost curve insects the demand curve determines the price and quantity.
Price = $P3 and output = $Q3.
E. Charging a price equal to the marginal cost would imply incurring a loss because the average cost curve lies above the MC curve. So the cost would be more than the price charged at every unit of output.
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