Author Question: If a natural monopoly is regulated using the marginal cost pricing rule, how does the regulation ... (Read 76 times)

tsand2 · **on:** Jun 29, 2018

If a natural monopoly is regulated using the marginal cost pricing rule, how does the regulation affect prices, outputs, profits, and the distribution of surpluses? What are the pros and cons to this method of regulation?

What will be an ideal response?

Question 2

Explain how an increase in the price of leather brought about by shift in tastes may lead to an increase in the supply of beef.

What will be an ideal response?

medine · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The marginal cost pricing rule sets the regulated price equal to the price where the marginal cost curve intersects the demand curve. This price is lower than the monopoly price, and results in a higher level of output. The monopoly's economic profit is eliminated; in fact, this rule results in the firm making economic losses, as marginal cost is less than average cost for a natural monopoly. Because output increases to the point where marginal cost equals price, consumer surplus is maximized. The advantage of this method of regulation is that it results in the efficient level of output. The disadvantage of this method is that means the firm will incur an economic loss. Unless subsidized by the government, the firm will eventually exit the industry, as no firm can operate at a loss in the long run.

Answer to Question 2

An increase in the price of leather will lead to an increase in the quantity of leather supplied. Thus, as ranchers raise more cattle (to increase the quantity of leather supplied), they will also have more beef to supply to the market.