Question

 The following graph shows the demand (D) for cable services in the imaginary town of Utilityburg. The graph also shows the marginal revenue (MR) curve, the marginal cost (MC) curve, and the average total cost (ATC) curve for the local cable company, a natural monopolist.

 On the following graph, use the black point (plus symbol) to indicate the profit-maximizing price and quantity for this natural monopolist.

 Which of the following statements are true about this natural monopoly? Check all that apply.

•  The cable company is experiencing diseconomies of scale.
•  The cable company is experiencing economies of scale.
•  It is more efficient on the cost side for one producer to exist in this market rather than a large number of producers.
•  The cable company must own a scarce resource.

 True or False: Without government regulation, natural monopolies can earn positive profit in the long run.

•  True
•  False

 

 

Answer 1

A natural monopoly will maximize profits by producing at the quantity where marginal revenue (MR) equals marginal costs (MC) and then charging the relevant price for this quantity. At MR= MC, p= $60 and q=8 units.

True statements about natural monopoly:

(ii) the cable company is experiencing economies of scale. - For a natural monopoly the long-run average cost curve (LRAC) falls continuously over a large range of output.

(iii) it is more efficient on the cost side for one producer to exist in this market rather than a large number of producers. -  A natural monopoly occurs when the most efficient number of firms in the industry is one.

Without government regulation, natural monopolies can earn positive profits in the long run.- True

Pricing mechanism	quantity	price	profit	long run decision
profit maximization	7	45	super normal profit	stay
marginal cost pricing	14	10	economic loss	exit
average cost pricing	13	15	normal profit	stay

Under profit maximization, the firm produces at MR=MC. Thus p=$45 and q =7.

Under marginal cost pricing, Price is set equal to MC, that is, P= MC= $10 and q=14.

Under average cost pricing, the firm produces where ATC= D, thus p= $15 and q= 13.

Under the average cost pricing, the company has no incentive to cut costs- True. Since p= average cost, if average cost increases the price will increase too. Hence the company has no incentive to cut costs.