8) The above figure represents the cost, market demand, and marginal revenue curves for a
monopoly.
a. Indicate the price and quantity a single-price monopoly selects by labeling the price Pm and
the quantity Qm.
b. In the figure, lightly shade in the area that represents the single-price monopoly’s economic
profit.
c. Indicate the quantity a perfectly price-discriminating monopoly selects by labeling it Qppd.
d. In the figure, more darkly shade in the area that represents the additional economic profit the
monopoly earns as a result of the perfect price discrimination.
15.12 Essay: Monopoly Regulation
1) “Under the social interest theory of regulation, regulators attempt to maximize profits for the
owners of the firms being regulated.” Is the previous statement correct or incorrect?
2) What is the social interest theory of regulation? How does it differ from the capture theory of
regulation?
3) “The theory that regulation seeks an efficient use of resources is called the capture theory of
regulation.” Is the previous statement correct or incorrect?
4) Describe the difference between social interest theory of regulation and the capture theory of
regulation.
5) Why are water companies considered a natural monopoly?
6) “If a natural monopoly is regulated using a marginal cost pricing rule, the firm earns zero
economic profit.” Is the previous statement correct or incorrect?
7) “If Michigan’s electric utilities were allowed to use marginal cost pricing, it would lead to
economic profits for these utilities.” Is the previous statement correct or incorrect?
8) When a natural monopoly is regulated using a marginal cost pricing rule, what can you say
about the firm’s profit and the market’s efficiency?
9) If a natural monopoly is regulated using the marginal cost pricing rule, how will that affect
prices, outputs, profits, and the distribution of surpluses? What are the pros and cons to this
method of regulation?
10) What is an average cost pricing rule? Why do regulatory agencies use it for natural
monopolies?
11) “When electric utilities are regulated using an average cost pricing rule, they will earn zero
economic profit.” Is the previous statement correct or incorrect? Why?
12) When a natural monopoly is regulated using an average cost pricing rule, what can you say
about the firm’s profit and the market’s efficiency?
13) Electric utilities are often considered natural monopolies and are regulated. When would the
price be highest: when the utility is not regulated, when it is regulated using an average cost
pricing rule, or when it is regulated using a marginal cost pricing rule? When would its price be
lowest?
14) Compare and contrast the marginal cost and average cost pricing rules for regulating natural
monopolies.
15) What is a marginal cost pricing rule and an average cost pricing rule? What are the
disadvantages and advantages of each?
16) Why do some utilities have an incentive to exaggerate their costs of production?
17) What potential problem is there with rate of return pricing?
18) How can managers of natural monopolies exaggerate their costs?
19) Briefly describe and discuss the different ways a natural monopoly can be regulated:
Marginal cost pricing, average cost pricing, rate of return regulation, and price cap regulation.
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20) In the figure above, complete the graph of the electric utility company by adding the
marginal revenue and marginal cost curves. Assume the marginal cost is constant at 4¢ per
kilowatt-hour. Now discuss the marginal cost pricing rule and the average cost pricing rule
regulators might use to regulate the firm. Be sure to state the price and quantity that are selected
for each option. Also, what price and quantity does the firm select if it is not regulated?
21) The above figure shows the demand for cable and the cable company’s cost of providing
cable.
a. What price and quantity will be produced if the company is unregulated and profit
maximizes?
b. What price and quantity will be produced if the company is regulated using the marginal cost
pricing rule?
c. What is the advantage of the marginal cost pricing rule?
d. What price and quantity will be produced if the company is regulated using the average cost
pricing rule?
e. What is the advantage of the average cost pricing rule?
22) The above figure illustrates the market for electric power that is served by the one utility in
Alberta, Canada.
a. If the government did not regulate this utility, what would be the price of a kilowatt hour in
this region and how much power would be generated?
b. If the government regulates the utility and chooses an average cost pricing rule, what would
be the price of a kilowatt hour and how much power would be generated?
c. If the government regulates the utility and chooses a marginal cost pricing rule, what would
be the price of a kilowatt hour and how much power would be generated?
23) The above figure represents the cost and demand curves for a natural monopoly that is
regulated using a marginal cost pricing rule.
a. What is the quantity?
b. What price is charged?
c. What area represents the consumer surplus when the firm is regulated using a marginal cost
pricing rule?
d. What distance represents the firm’s loss per unit when the firm is regulated using a marginal
cost pricing rule?
24) The above figure shows the demand, marginal revenue, and cost curves for a natural
monopoly.
a. Which price and quantity is set if the capture theory is correct?
b. If production is at the price and quantity specified in part (a), what area represents the
economic profit?
c. If production is at the price and quantity specified in part (a), what area represents the
deadweight loss?
d. If production is at the price and quantity specified in part (a), what area represents the
consumer surplus?