Chapter 13: Natural Monopolies: (De)Regulation?
Solutions Manual
Learning Objectives for Chapter 13
After reading this chapter, you should know
LO 13-01. The characteristics of natural monopoly.
LO 13-02. The regulatory dilemmas posed by natural monopoly.
LO 13-03. The costs associated with regulation.
LO 13-04. How deregulation has fared in specific industries.
Questions for Discussion
1. Given the inevitable limit on airplane landings, how should available airport slots be
allocated? How would market outcomes be altered? (LO 13-02)
2. Why would a profit-regulated firm want to sell itself inputs at inflated prices? Or increase
wages? (LO 13-03)
3. Prior to 1982, AT&T kept local phone rates low by subsidizing them from long-distance
profits. Was such cross-subsidization in the public interest? Explain. (LO 13-01)
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4. In most cities local taxi fares are regulated. Should such regulation end? Who would gain or
lose? (LO 13-03)
5. How would you put dollar values on the benefits and costs of truck safety regulations (News,
p. 288)? Do benefits exceed costs? (LO 13-02)
6. The Telecommunications Act of 1996 requires local phone companies to charge “reasonable”
rates for transmission access. What is a “reasonable” rate? (LO 13-04)
7. How could a local phone or cable company reduce service quality if forced to accept price
ceilings? (LO 13-02)
8. Had cable TV prices stayed low, would satellite TV service have spread as fast? (LO 13-04)
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
9. Do we allocate too many resources to regulatory agencies (Table 13.1)? What is the optimal
size of these agencies? (LO 13-03)
10. Should the Justice Department have approved the merger of American Airlines and U.S.
Airways in 2013? Who gained and who lost from that merger? (LO 13-04)
11. Many state and local governments have banned ride-sharing services like Uber and Lyft,
citing the lack of safety regulation (as with taxi cabs). Is this appropriate? (LO 13-03)
Problems
1. In Figure 13.2,
(a) How much profit does an unregulated monopolist earn?
(b) How much profit would be earned if MC pricing were imposed? (LO 13-02)
Answers:
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Feedback:
(a) Profit maximization occurs where MR = MC, at point A. If unregulated, a natural
(b) Regulation designed to achieve efficient prices will seek point B, where P = MC. In a
2. Do total profits (A) decrease, (B) increase, or (C) stay the same when new technology
reduces average total costs (shifts ATC downward in Figure 13.2) in
(a) An unregulated natural monopoly?
(b) A price-regulated natural monopoly?
(c) A profit-regulated natural monopoly? (LO 13-01)
Answers:
Feedback:
(a) Since Profit = Total Revenue – Total Cost = (Price – ATC) × Quantity, and the firm’s
(b) Price regulation means that the government sets a maximum price (a price ceiling)
that a company can charge, which is usually associated with a company’s marginal
(c) Profit regulation usually mandates a firm set its price equal to ATC. Therefore, if a
3. Suppose a natural monopolist has fixed costs of $15 and a constant marginal cost of $3.
The demand for the product is as follows:
Price (per unit) $1
0
$
9
$
8
$
7
$
6
$
5
$
4
$
3
$
2
$1
Quantity 0 2 4 6 8 1 1 1 1 18
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Demanded
(units per day)
0 2 4 6
Under these conditions,
(a) What price and quantity will prevail if the monopolist isn’t regulated?
(b) What price–output combination would exist with efficient pricing (MC = p)?
(c) What price–output combination would exist with profit regulation (zero economic
profits)?
Illustrate your answers on the graph below. (LO 13-02)
Answers:
Price Quantity
Total
Revenue
Marginal
Revenue
Total
Cost
Average
Cost
Marginal
Cost
Profit
$10 0 $0 — $15 — — -$15
$9 2 $18 $9 $21 $10.50 $3 -$3
$8 4 $32 $7 $27 $6.75 $3 $5
$7 6 $42 $5 $33 $5.50 $3 $9
$6 8 $48 $3 $39 $5.00 $3 $9
$5 10 $50 $1 $45 $4.88 $3 $5
$4 12 $48 –$1 $51 $4.25 $3 -$3
$3 14 $42 –$3 $57 $4.07 $3 -$15
$2 16 $32 –$5 $63 $3.94 $3 -$31
$1 18 $18 –$7 $69 $3.83 $3 -451
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0 2 4 6 8 10 12 14 16 18
-8
-6
-4
-2
0
2
4
6
8
10
12
Natural Monopolist Curves
Demand
ATC
MR
MC
Quantity (unit s per period)
Price/Cost (dollars per unit )
Feedback:
(a1) Based on a marginal cost of $3 and fixed costs of $15, the following table shows the
(a2) Once again a natural monopoly will produce where MC = MR if unregulated. The
(b1) Efficient pricing requires a natural monopolist to set price equal to marginal cost. In
(b2) If this natural monopolist were expected to use efficiency pricing and charge a price
(c1) Profit regulation involves mandating a price equal to average total cost, and thus a
(c2) Price equals closest to average total cost (and a zero profit) at 12 units of output.
(d) Plot demand by finding the highest price and the lowest price given, these are the
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
4. According to the News on page 288, how much will annual shipping costs increase for
each saved life? (LO 13-03)
Feedback: This regulation costs trucking companies an estimated $2 billion per year and
5. If the average U.S. worker produces $100,000 of output per year, what is the annual
opportunity cost of the federal regulatory workforce (Table 13.1)? (LO 13-03)
Feedback: The 281,527 people employed in 63 federal agencies (as well as the tens of
6. Suppose a corporation has two subsidiaries, one of which is unregulated and sells all of
its output to the other, regulated subsidiary. Permitted profits at the regulated subsidiary
are equal to 10 percent of total costs. Here is the initial profit picture for the subsidiaries:
Unregulated Subsidiary Regulated Subsidiary
Total revenue $800,000 N/A
Total costs $500,000 $ 1 million
Total profit $300,000 $ 100,000
If the unregulated subsidiary doubles its selling price, what happens to profits at
(a) The unregulated subsidiary?
(b) The regulated subsidiary? (LO 13-04)
Answers:
Feedback:
(a) The unregulated subsidiary sells all of its output to the regulated subsidiary. This
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.