Question

               Electricity distribution in upstate New York is provided by only one firm, NYSEG.   Demand for electricity is characterized by P=31-Q_D, and NYSEG has a total cost function TC(Q)=72+Q+2Q^2, and a marginal cost function MC(Q_D )=1+4Q.

a. What is NYSEG’s marginal revenue equation?

b. What is the quantity and price NYSEG will choose? Show your math for full credit.

c. Will NYSEG be able to operate in the market in the short run? What about the long run? Explain briefly.

d. What is the barrier that allows for NYSEG to operate as a monopoly? Explain briefly.  

Answer 1

(a) Demand: P = 31 - QD

Total revenue (TR) = P x QD = 31QD - QD²

Marginal revenue (MR) = dTR/dQD = 31 - 2QD

(b) Profit is maximized when MR equals MC.

31 - 2Q = 1 + 4Q

6Q = 30

Q = 5

P = 31 - 5 = 26

(c) TC = 72 + Q + 2Q²

Total variable cost (TVC) = Q + 2Q²

Average variable cost (AVC) = TVC/Q = 1 + 2Q

Average total cost (ATC) TC/Q = (72/Q) + 1 + 2Q

In short run, firm will operate if Price > AVC (i.e. if AVC < P).

When Q = 5, AVC = 1 + (2 x 5) = 1 + 10 = 11 < Price, therefore firm will operate in short run.

In long run, firm will operate if Price > ATC (i.e. if ATC < P).

When Q = 5, ATC = (72/5) + 1 + (2 x 5) = 14.4 + 1 + 10 = 25.4 < price, therefore firm will operate in long run.

(d) From cost function, there is a fixed cost equal to 72 units, which acts as the barrier to entry. Therefore NYSEG continues to operate as a monopolist without any competitors. In addition, this may be an example of government-created monopoly.