Consider the local telephone company, a natural monopoly. The following graph sh
ID: 1210662 • Letter: C
Question
Consider the local telephone company, a natural monopoly. The following graph shows the monthly demand curve for phone services, the company's marginal revenue (MR), marginal cost (MC), and average total cost (ATC) curves. Suppose that the government has decided not to regulate this industry, and the firm is free to maximize profits, without constraints. Complete the first row of the following table. Suppose that the government forces the monopolist to set the price equal to marginal cost. Complete the second row of the previous table. Suppose that the government forces the monopolist to set the price equal to average total cost.Explanation / Answer
(a) Monopolist maximizes profits by equating MR with MC, and profit = Q x (P - ATC)
Q = 8,000
P = $60
ATC = $30
Profit = 8,000 x $(60 - 30) = 8,000 x $30 = $240,000
Long run decision is to Stay in market (Since profit is positive).
(b) P = MC = MR
Q = 16,000
P = MC = $20
ATC = $25
Profit = 16,000 x $(20 - 25) = 16,000 x (- $5) = - $80,000 (Loss)
Long run decision: Exit market (Since profit is negative)
(c) P = ATC = MR
Q = 7,000
P = ATC = $30
Profit = 0
Long run decision: Exit