Question

Suppose that after graduating from college with an economics degree, you get a job with your state’s public utilities commission. Your job is to determine the regulated price for an electric utility (a natural monopoly). The figure below shows the current situation in the market.
 

 

1st attempt

Part 1   (1 point)

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If the electric utility was unregulated, it would earn   $   in economic profits.
 

Part 2   (1 point)

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If you set a regulated price to achieve economic efficiency, the electric utility would earn   $  .

Part 3   (1 point)

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If the electric utility is forced to charge a price that leads to economic losses, it would go out of business, and consumers would have no electricity. To avoid this, the government has several possible solutions at its disposal. Assuming the government still wanted to maintain some protection for consumers, which of the following is NOT a possible solution?

Choose one:A.  The government could own and operate the electric utility.B.  The government could set the regulated price equal to average cost so that the firm breaks even.C.  The government could subsidize the losses the utility would earn if it (the utility) charged $7.D.  The government could allow the electric utility to operate as an unregulated firm.
 

Answer 1

As the electricity unit is unregulated, the firm decides to operate where the marginal cost equates to the marginal revenue. Thus, the firm would charge \(\$ 18\) for 100 units of electricity. Thereby, earning a profit of \(\$ 200=(\$ 18-\$ 16) * 100\).

If the government sets a regulatory price in order to achieve economic efficiency, the monopolist would operate when the price is equal to marginal cost. Thus, the price is set at \(\$ 7\). So, the firm would sell 200 units of electricity. Thereby, it would earn \(Q \times(A R-A C)=200 \times(7-11)=-4 \times 200=-800 .\)

As the electric utility is earning negative profits, they would go out of business. The government can subsidize the losses incurred by the firm or it could purchase Electric Utility or the firm could set the price at average cost so that the firm zero profits.

Thus, the only option left is (A). The incorrect option is (A).

Answer 2

The correct answer for Part 3 is D