Question

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? 

• Work to decrease its costs 

• Allow its costs to increase

Answer 1

Pricing Mechanism	Q	P	Profit	Long Run Decision
Profit Maximizing	7000	65	Positive	Stay in Business
MC Pricing	14000	30	Negative	Exit the Business
AC pricing	13000	35	Zero	Stay or Exit

Select "Allow its cost to increase"