Consider the only electric company in a small town, which you can assume operates as a natural monopoly. The following graph shows the demand curve for electricity services per month, as well as the provider’s marginal revenue (MR) curve, marginal cost (MC) curve, and average total cost (ATC) curve. Suppose the government has elected not to impose regulations on the industry, and so the firm faces no regulatory constraints in maximizing profits.
Complete the first row of the following table.
Pricing Mechanism
Short Run
Long-Run Decision
(options are: exit the industry,
stay in business,
stay or exit)
Quantity
Price
Profit
(options are: negative,
positive, zero)
(Subscriptions)
(Dollars per subscription)
Profit Maximization Marginal-Cost Pricing Average-Cost Pricing Suppose now that the government decides to require the monopolist to set its price equal to marginal cost.
Complete the second row of the previous table.
Suppose now that the government decides to require the monopolist to set its price equal to average total cost.
Complete the third row of the previous table.
True or False: Over time, the electric company has a very strong incentive to lower costs when subject to average-cost pricing regulations.
True
False