Consider the local cable company, a natural monopoly. The following graph shows
ID: 1217545 • Letter: C
Question
Consider the local cable company, a natural monopoly. The following graph shows the monthly demand curve for cable services, the company's marginal revenue (MR), marginal cost (MC), and average total cost (ATC) curves. 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. Complete the third row of the previous table. True or False: Under the average-cost pricing policy, the cable company has no incentive to cut costs. True FalseExplanation / Answer
First row:
Profit-maximizing monopolist will set MR=MC. This will give Q=8 as shown by the intersection of MR and MC curves in graph. Corresponding P=50. Profit is given by PQ-ATC(Q)=50(8)-20(8)=240. In long run monopolist will stay in market and continue to make profits
Second row:
If government forces to charge P=MC, then as shown by the intersection of P and MC curves, P=10 and Q=16. Profit is given by PQ-ATC(Q). Note that ATC at Q=16 looks just below 15 in graph but exact value is not clear from the graph. But still we can impute ATC by figuring out fixed cost using MC and ATC at some other Q, say Q=8. Clearly fixed cost, FC=ATC(Q)-MC(Q)=20(8)-10(8)=80. Thus ATC at Q=16 is given by (16MC+FC)/16=15. So profit=PQ-ATC(Q)=16(10)-16(15)=-80. Since monopolist is making losses in long run it will exit in the absence of any government subsidy.
Third row:
In this case relevant price and quantity are given by intersection of ATC and D curve. Thus Q=15 and P=15. Profit=PQ-ATC(Q)=15(15)-15(15)=0. It will stay in the market (though indifferent to exiting) as its breaking even.
The table below has the required values based on above explanation:
True: Under the average cost pricing policy since monopolist will make 0 profit regardless of cost it has no incentive to cut cost.
8 50 240 stay 16 10 -80 exit 15 15 0 stay