Question

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Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to "Calculate," you must show how you arrived at your final answer L2 P Power is a natural monopoly supplying electricity for a city. The firm produces the profit- maximizing quantity of electricity and earns a positive economic profit. (a) Describe a condition that distinguishes a natural monopoly from a typical monopoly. (b) Draw a correctly labeled graph for the natural monopoly market in which L2 P Power operates and show each of the following. (1) The profit-maximizing quantity, labeled QM (ii) The profit-maximizing price, labeled PM (iii) The area representing economic profit, shaded completely Suppose the government wants to regulate L2 P to produce the maximum quantity that would allow it to earn zero economic profit. On your graph in part (b), show the maximum quantity it will produce to earn zero economic profit, labeled QR, and price, labeled Pr. P to produce the allocatively (d) Suppose instead the government wants to regulate L efficient quantity. (i) Does L2 P earn positive economic profit if it produces the allocatively efficient quantity? Explain. (ii) Under what condition will L2 P agree to produce the allocatively efficient quantity? Please respond on separate paper, following directions from your teacher.

Answer 1

Power as a natural monopoly:-

A natural monopoly exists when average costs continuously fall as the firm gets larger. An electric company is a classic example of a natural monopoly. Once the gargantuan fixed costs involved with power generation and power lines is payed, each additional unit of electricity costs very little; the more units sold, the more the fixed costs can be spread, creating a reasonable price for the consumer. Having two electric companies split electricity production, each with their own power source and power lines would lead to a near doubling of price. Clearly, competition, the flagship of the American economy, is not always the answer.

Distinguished Between Natural and Typical Monopoly:-

A natural monopoly is a situation where a monopoly is actually the most efficient outcome. Telephone lines were a classic example (at least before the proliferation of cellular technology). The logical thing would be for one company (or government entity) to own the phone lines; it wouldn't make sense for two competing companies to have phone lines running parallel to each other. The cost of building them would be too high.First of all, the term Typical monopoly has different meanings to different economists. ... A natural monopoly, on the other hand, supposedly has "natural" barriers to entry. Instead of the government forcefully preventing competition, a natural monopoly excludes competitors with high costs of entry or physical barriers.

Graph for Natural Monopoly in market:-

Costs & Revenue Long Run Average Costs continue to fall as economies of scale are generated --- ---- IA Long Run Average Cost Long Run Marginal Cost P1 --OG- AR 01 MR Output

Profit maximizing quality:-

Profits can be maximized by increasing per unit revenue, decreasing unit cost or a mix of both. ... Maximizing profit by reducing quality should be avoided as it threatens long term survival.

In economics, profit maximization is the short run or long run process by which a firm may determine the price, input, and output levels that lead to the highest profit. Neoclassical economics, currently the mainstream approach to microeconomics, usually models the firm as maximizing profit.

Profit maximizing price:-

Profit maximization is the short run or long run process by which a firm determines the price and output level that returns the greatest profit. Any costs incurred by a firm may be classed into two groups: fixed costs and variable costs.Profit is maximized at the quantity of output where marginal revenue equals marginal cost. ... Set marginal revenue equal to marginal cost and solve for q. Substituting 2,000 for q in the demand equation enables you to determine price. Thus, the profit-maximizing quantity is 2,000 units and the price is $40 per unit.

Economic Profit:-
An economic profit or loss is the difference between the revenue received from the sale of an output and the costs of all inputs used and any opportunity costs. In calculating economic profit, opportunity costs and explicit costs are deducted from revenues earned.

Opportunity costs are a type of implicit cost determined by management and will vary based on different scenarios and perspectives.

Allocatively efficient quantity:-

Allocative efficiency is a state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing.

In contract theory, allocative efficiency is achieved in a contract in which the skill demanded by the offering party and the skill of the agreeing party are the same.

Although there are different standards of evaluation for the concept of allocative efficiency, the basic principle asserts that in any economic system, choices in resource allocation produce both "winners" and "losers" relative to the choice being evaluated. The principles of rational choice, individual maximization, utilitarianism and market theory further suppose that the outcomes for winners and losers can be identified, compared and measured. Under these basic premises, the goal of attaining allocative efficiency can be defined according to some principle where some allocations are subjectively better than others. For example, an economist might say that a change in policy is an allocative improvement as long as those who benefit from the change (winners) gain more than the losers lose (see Kaldor–Hicks efficiency).

An allocatively efficient economy produces an "optimal mix" of commodities.A firm is allocatively efficient when its price is equal to its marginal costs (that is, P = MC) in a perfect market. The demand curve coincides with the marginal utility curve, which measures the (private) benefit of the additional unit, while the supply curve coincides with the marginal cost curve, which measures the (private) cost of the additional unit. In a perfect market, there are no externalities, implying that the demand curve is also equal to the social benefit of the additional unit, while the supply curve measures the social cost of the additional unit. Therefore, the market equilibrium, where demand meets supply, is also where the marginal social benefit equals the marginal social costs. At this point, net social benefit is maximized, meaning this is the allocatively efficient outcome. When a market fails to allocate resources efficiently, there is said to be market failure. Market failure may occur because of imperfect knowledge, differentiated goods, concentrated market power (e.g., monopoly or oligopoly), or externalities.

In the single-price model, at the point of allocative efficiency price is equal to marginal cost.At this point the social surplus is maximized with no deadweight loss (the latter being the value society puts on that level of output produced minus the value of resources used to achieve that level). Allocative efficiency is the main tool of welfare analysis to measure the impact of markets and public policy upon society and subgroups being made better or worse off.

It is possible to have Pareto efficiency without allocative efficiency: in such a situation, it is impossible to reallocate resources in such a way that someone gains and no one loses (hence we have Pareto efficiency), yet it would be possible to reallocate in such a way that gainers gain more than losers lose (hence with such a reallocation, we do not have allocative efficiency).