Question

A government can reduce the welfare inefficiencies caused by a monopoly by

		imposing tariffs.
		setting the price to the Average Total Cost.
		taxing the monopoly.
		All of the above.

Answer 1

Option D

The average cost pricing rule is a regulatory requirement that a business charge its customers a maximum amount based on the average unit cost of production.The rule is usually applied only to natural or legal monopolies, such as public utilities, in order to prevent price-fixing or other types of monopolistic advantage.Because of competition among firms in free market situations, prices offered by producers will tend to fall to their average cost of production over time as one company competes for the market share of the others by offering the lowest cost product.As fixed cost is independent of the level of output, imposition of such will not alter MC of the monopolist. Hence the equilibrium in the monopoly market will remain the same and, consequently, output and price will remain unchanged. The only change that will occur is the reduction of profit of the monopolist. Under imperfect competition price exceeds marginal cost, so that a country which imports such a good pays a rent to the foreign firm (unless the firm happens to earn only normal profits). Tariffs can be used to extract some of this rent.In the special case in which a domestic entrant would produce only for its home market, some rent can be extracted without reducing the level of imports or domestic consumption of the good.