skywalker Farms supplies water to the town of Mos Eisley (they are \\the water c
ID: 1241974 • Letter: S
Question
skywalker Farms supplies water to the town of Mos Eisley (they are he water company",i.e. a monopoly supplier). Given their infrastructure of pipes, treatment centers, etc, the marginal cost of
supplying one gallon of water is only $.50 (and is constant), though maintaining their infrastructure has a
daily xed cost of $75,000. Mos Eisley's daily demand for gallons of water is P = 20
1
1000Q.
a. Solve for Skywalker Farm's prot-maximizing price. What daily prot do they earn when they charge
this price?
b. Emperor Palpatine, in a rare burst of populism, suggests regulating Skywalker Farms by capping the
price they are allowed to charge at $9/gallon of water. What prot will Skywalker Farms earn at this price?
c. You are hired as a consultant to advise the Galactic Empire on this matter. Explain in words why such
a price ceiling might be a good idea (i.e. could such a price ceiling be welfare-improving? Consult page 372,
on natural monopoly).
Explanation / Answer
a. Skywalker Farms will charge a price of $10.25 (selling a quantity of 9,750 gallons of water), and earns a pro?t of $20,062.50. b. We saw in part a that Skywalker Farms would like to charge a price of $10. Here, they are prohibited from doing so by the government, and must charge a price of only $9. At this price, the quantity demanded is 11,000, and so their pro?ts are $18,500. c. A monopolist has an incentive to decrease the amount of output sold relative to what would be e?cient (where willingness to pay as measured by the demand curve equals marginal cost). This results in a deadweight loss. A price ceiling dampens this incentive, increasing the amount of output produced, and decreasing the amount of deadweight loss.
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