Question

Policy Memo 2 Oneandonly Cable Company

Background: You work for the Public Utility Commission (PUC) in the City of Solo, Utah with a population of 150,000 people. The Oneandonly Cable Company is the only cable company licensed to operate in Solo. Most of Oneandonly’s costs are access fees and maintenance expenses. These fixed costs total $640,000 monthly. The marginal cost of adding another subscriber to the system is $2 per month. Oneandonly’s demand curve can be determined from the following data: Subscription Price (per month) Number of Subscribers (per month) $25 20,000 $20 40,000 $15 60,000 $10 80,000 $5 100,000 $2 112,000 The people in the City of Solo are complaining that their $15/month subscription price Oneandonly is currently charging is too expensive. As an analyst for the Public Utility Commission, you have been asked to consider the following options to address the citizen’s concern:

1. Force average cost pricing on Oneandonly. 2. Force marginal cost pricing on Oneandonly. 3. Leave things as they are. You have been asked to prepare a brief memo for the PUC analyzing these three policy options. Specifically, PUC would like for you to consider the following in your analysis for each policy option.  What is the price of a monthly subscription?  What are the profits or losses Oneandonly is making?  Is Oneandonly likely to stay in business?  Is this the most efficient market solution? Your memo should address each of the impacts requested above and should include a recommendation as to which policy (if any) the PUC should support. In addition, you are welcome to propose another policy if you have one. As the contents of your memo will be used to prepare the PUC for a decision they will need to explain to the public, it is important that this information be presented in a direct, non-technical manner that is accessible to non-economists. As such, the PUC has asked that you limit your analysis to two pages and to limit the use of economic jargon. Be sure to include a table summarizing your results. Since the PUC does have economic training, it is allowable to supplement your two-page memo with additional tables that illustrate your analysis. However, any explanations provided in the memo itself must be presented in a way that allows the PUC to convey the information to others in a nontechnical manner. Hints to get you started:  Expect to make a table with more information, such as TFC, MC, etc., for any supplemental tables you would like to turn in. However, all of this information may not easily understandable for the policy memo (2-page) part, so consider what information to include in your memo table carefully.  I recommend Excel or another spreadsheet software to carry out the calculations.  In class we have been calculating marginal revenue assuming there is one unit change in quantity. The equation for marginal revenue is the change in total revenue divided by the change in quantity

Answer 1

Average pricing refers to the pricing strategy of setting the price slightly above the average cost. The average cost is obtained by dividing the total cost of production by the number of units produced. The total cost of production considers both the fixed and variable cost of production hence in average cost pricing strategy both fixed and variable cost are considered as a result average pricing strategy enables the firm to earn normal profit. Normal profit refers to the profit earned at the price level where both the total explicit and implicit cost of the firm is covered by the total revenue of the firm and the difference between the total revenue and the sum of the total explicit and implicit cost is zero. Unlike marginal cost which considers only the variable cost and does not guarantee normal profit for the firm. However average cost is greater then marginal cost and hence the price will be greater than marginal cost. Regulators usually impose average cost pricing strategy on natural monopolies as it enables the firm to earn normal profit and not higher economic profit or super normal profit.

Marginal pricing refers to the pricing strategy of setting the price slightly above the variable cost or marginal cost. Such pricing strategy is usually adopted by the firm when it is unable to allure the customers hence to attract the customers it sets the price at the minimal level through marginal pricing such pricing is favorable from the customers point of view as they have to pay minimum price but it is usually unfavorable for the business in the long run. In marginal pricing the profits earned by the firm if at all is minimum. Normal profit is not guaranteed when marginal cost pricing strategy is adopted which is why firms prefer average cost pricing strategy over marginal cost pricing strategy. Marginal cost pricing strategy is not sustainable for the business in the long run as it does not cover the fixed costs, any scope of improving the quality of the service or products, making investments to improve future prospects, production capacity etc is grim as the firm will not be able achieve the wherewithal to make investments on improving its products, capacity, prospects etc with such pricing strategy as it ignores the long term objectives of the business and just focuses on the short term objective of improving sales through attractive pricing.

Since the price established through marginal cost pricing is usually less than that through average cost pricing as it is favored by the consumers. Marginal pricing reduces the burden of the consumers and increases the burden of the producer.

Leave the  situation as it is, currently the firm in question is earning a revenue of 900,000 Dollars and a profit of assuming that the subscription fee is 15 Dollars and the number of current subscribers is 60,000 and fixed cost at 640,000 and variable cost at 120,000 Dollars at 2 Dollars per subscriber (2 * 60,000 ). Hence the total profit would be 900,000 - 640,000 - 120,000 = 140,000. Hence the firm is earning more then normal profit. It is vital to ensure that the monopolistic firm does not exploit its monopolistic position and it is the duty of the regulator to ensure this hence it is not advisable to leave the situation as it is, as the consumers are not pleased with the pricing strategy of the firm and the complaints made by the consumers are reasonable considering the pricing strategy and profit margin of the firm. Hence measures to ensure that the firm adopts a pricing strategy which enables them to earn a reasonable revenue without disappointing the consumers is imperative. If the firm adopts a reasonable pricing strategy it can also cater to a larger consumer base thus satisfying the needs of a larger audience. Being the only firm in the industry it is imperative to meet the demands of a wider audience and not ignore them as they will not have any other source which they can resort to, to meet their needs. It is the duty of the regulator to ensure that the needs of the masses are met in a satisfactory manner.

Recommendation - It would be in everybody's  interest if the PUC intervenes and ensures that Oneandonly cable company adopts a pricing strategy which enables it to earn a normal profit and any profit which is more than that would be be a cause of disappointment for the consumers, which is currently the case.

Average cost pricing strategy will enable Oneandonly cable company to earn normal profit and provide a satisfactory service to the consumers without overburdening them with higher price and earning a revenue which would suffice the coverage of the total explicit and implicit cost incurred by the company thus ensuring a reasonably healthy financial position for the company. Thus the current crib of the consumers would be acknowledged in a sustainable way with the adoption of Average cost pricing strategy without jeopardizing the financial health and survival of the company. Average cost pricing strategy would also enable the company to cater to a greater audience as it would mean the company lowering its price from the current level thus being accessible to a larger customer base in the future due to lowered price. Marginal cost pricing strategy though it pleases and addresses the complaints of the consumers through lowered price, it is not sustainable for the company in the long-run as it ignores and jeopardizes the long term interest and objectives of the company, threatening the survival of the firm in the long run.

Hence adoption of Average cost pricing strategy would be in everybody's interest as it will cater to the needs and demands of both the consumers and the company without compromising anybody's interest.