Question

Consider a monopolist that pollutes and we know the following about the market: Demand ... 1. Consider a monopolist that pollutes and we know the following about the market: Demand is given by Q=10-P. Total private costs of production is C=2*Q Marginal external costs, or damages, are $6/unit, or MEC=6 Regulators are trying to decide what to do and need you to evaluate the net benefits of 3 different scenarios:

i. Leave the firm alone. Don’t regulate and let it act like a monopolist.

ii. Impose a per-unit tax on the monopoly equal to marginal external costs.

iii. Break up the firm and make it operate like a perfectly competitive market.

a. Compare the results for (i), (ii), and (iii). Rank them from the highest net benefits to the lowest.

b. Are any of these 3 options the best possible outcome or is there another policy that would be better still? If there is an even better option, why is it better and what are the net benefits of that policy?

c. Write a short summary to a policy maker (e.g., a legislator who wants to know what economics suggests) describing why the best option is, in fact, and parties that gain and lose

Answer 1

i)

Monopolist Price and Quantity:

Q = 10 – P

P = 10 – Q

TR = (10 –Q)Q

= 10Q –Q^2

MR = 10 – 2Q   …..(1)

C = 2Q

MC = 2                      …..(2)

MR = MC

10 -2Q = 2

2Q = 8

Q = 4

P = 10 -4

= $ 6

ii)

New TC after imposing per unit tax:

C = 2Q +6Q

= 8Q

MC = 8

Equilibrium; MR = MC

10 – 2Q =8

Q = 1

P = 10 -1

= $ 9

iii)

Competitive Market Equilibrium:

P = MC

10 –Q = 2

Q = 8

P = 10 -8

= $ 2

Including per unit tax:

10 –Q = 8

Q = 2

P =8

a)

Profits in Monopolist:

TR – TC

=4*6 – 2(4)

= $24 – $8

= $ 18

Profit with tax:

=1*9 – 8*1

=9-8

= $ 1

Profit in competitive Market:

TR – TC

=8*2 -8*2

=16-16

= 0

TR – TC

=2*8 – 8(2)

=16 -16

= 0

b) This is case of negative externalities where producer does not take into account externalities. Here producer is required to reduce level of output to reach socially optimal level. Hence, monopoly already operates at inefficient level and produces less quantity. Hence, here monopoly tends to under produce. We must choose monopoly.

c) This is case of negative externalities. In case of negative externalities, competitive market tends to overproduce relative the monopoly market. Hence, in case of negative externalities monopoly market or firm should be preferred over the perfectly competitive market.