Question

9. Regulating a natural monopoly 

Consider the local telephone company, a natural monopoly. The following graph shows the monthly demand curve for phone services and the company's marginal revenue (MR), marginal cost (MC), and average total cost (ATC) curves. 

Suppose that the government has decided not to regulate this industry, and the firm is free to maximize profits, without constraints. 

Complete the first row of the following table. 

Suppose that the government forces the monopolist to set the price equal to marginal cost. 

Complete the second row of the previous table. 

Suppose that the government forces the monopolist to set the price equal to average total cost. 

Complete the third row of the previous table. 

Under average-cost pricing, the government will raise the price of output whenever a firm's costs increase, and lower the price whenever a firm's costs decrease. Over time, under the average-cost pricing policy, what will the local telephone company most likely do? 

• Allow its costs to increase 

• Work to decrease its costs

Answer 1

The information in the table is correct as when the firm maximizes profit, it will set MC=MR where profits are positive

AT the marginal cost pricing, the profits are negative and at the AC pricing, the total revenue = total cost.

Under the AC pricing, the telephone company most likely - allow its costs to increase