Question

Which of the following correctly completes the statement: "according to standard economic theory, the effect of a price control set by government below the unregulated price but above (or equal to) the average total cost for firms is to:

increase quantity supplied in a competitive market, but decrease quantity supplied in a natural monopoly market.

reduce quantity supplied in a competitive market, but increase quantity supplied in a natural monopoly market.

reduce quantity supplied in both a competitive market and in a natural monopoly market.

increase quantity supplied in both a competitive market and in a natural monopoly market.

Answer 1

according to standard economic theory, the effect of a price control set by government below the unregulated price but above (or equal to) the average total cost for firms is to:

now firstly when the government sets price control below unregulated price it means that at this new price demand is more than supply. so it is clear to reach equilibrium we need to INCREASE QUANTITY SUPPLIED.

A natural monopoly is a type of monopoly that exists due to the high start-up costs of conducting a business in a specific industry. A company with a natural monopoly might be the only provider or a product or service in an industry or geographic location. A natural monopoly arises when average costs are declining over the range of production that satisfies market demand. This typically happens when fixed costs are large relative to variable costs. A natural monopoly will maximize profits by producing at the quantity where marginal revenue (MR) equals marginal costs (MC) and by then looking to the market demand curve to see what price to charge for this quantity.

A natural monopoly has economies of scale. It can provide enough output to meet the entire market demand at a lower average total cost than two or more firms. A marginal cost pricing rule is a price rule for a natural monopoly that sets price equal to marginal cost.

for natural monopolist the price is above ATC according to question.

so price > ATC

Which implies that total revenue is greater than Total cost. thus he is already earning profits. since he is earning profits even at new set price he will produce more. supply will increase.

ans D

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