Question 1

Consider a natural monopoly that has declining LRAC over the entire range of the market demand curve.If it is regulated and required to charge a price that is equal to MC,the resulting level of output is

Accepted Answer

In a natural monopoly with declining LRAC, if the firm is required to charge a price equal to marginal cost (MC), it will be allocatively efficient because price equals MC. However, because the average cost is above MC at this point (due to declining LRAC), the firm will incur losses and require a subsidy to stay in business.

Question 2

The economic efficiency of a natural monopoly can be improved with the use of two -part tariffs because it allows the monopoly to

Accepted Answer

Two-part tariffs allow natural monopolies to charge users separately for fixed and variable costs. This enables them to allocate their fixed costs (such as infrastructure) over a larger user base, reducing the average cost per unit and promoting economic efficiency. It also allows them to charge a lower per-unit price, which can increase demand and overall revenue. Therefore, option D is the correct answer. The other options do not accurately describe the benefits of two-part tariffs for natural monopolies.

Question 3

Consider a regulated natural monopoly,such as an electricity distribution company,that faces falling long -run average costs.If it is forced to price its output at average cost it will provide

Accepted Answer

If the regulated natural monopoly is forced to price its output at average cost, it will not be able to cover its fixed costs and earn a reasonable profit. As a result, it will provide less output than what is socially optimal, leading to a deadweight loss. Therefore, the best choice is A.

Question 4

Which of the following is the definition of consumer surplus?

Accepted Answer

Consumer surplus is the difference between the value that consumers place on a good (which can be measured by their willingness to pay) and the payment they make to buy the good, summed over the quantity consumed. This represents the extra benefit or satisfaction derived by consumers from paying a price lower than what they were willing to pay.

Question 5

Choose the statement that best describes the dilemma facing the regulator of a natural monopoly.

Accepted Answer

Marginal-cost pricing in the context of a natural monopoly often results in losses because the marginal cost is below the average cost at the socially optimal level of production. This means the firm cannot cover its total costs if it prices at marginal cost. On the other hand, average-cost pricing allows the firm to cover its costs (since price is set equal to average cost) but leads to allocative inefficiency because the price will be above the marginal cost, leading to lower consumption than the socially optimal level. This creates a dilemma for regulators between choosing an efficient allocation of resources (marginal-cost pricing) and ensuring the financial viability of the monopoly (average-cost pricing).

Question 6

In the long run,the imposition of average-cost pricing in natural monopolies,such as Manitoba Hydro and New Brunswick Power,would generally lead to

Accepted Answer

The imposition of average-cost pricing in natural monopolies would lead to distorted investment decisions because these firms would not have the incentive to lower their costs and become more efficient, as they would still be able to cover their costs through the price set by the regulator. This could lead to inefficient allocation of resources and overall reduced economic welfare. Neither allocative efficiency nor productive efficiency is promoted by average-cost pricing in natural monopolies.

Question 7

In which of the following situations would a natural monopoly exist?

Accepted Answer

The answer of In which of the following situations would...

Question 8

Consider a public utility that is a natural monopoly with falling long-run average costs.If a regulatory agency ordered this firm to price all of its output at marginal cost,then the firm

Accepted Answer

In a natural monopoly with falling long-run average costs, pricing at marginal cost would result in revenues that are less than the total costs, leading to losses unless the firm receives subsidies. This is because the average cost is above the marginal cost in such a scenario, and selling at marginal cost doesn't cover the average costs of production.

Question 9

Which of the following is an example of an industry that succeeds in formally restricting entry,thereby maintaining prices above competitive levels?

Accepted Answer

Dentistry is an example of an industry that restricts entry through formal education and licensing requirements. Dentists must complete a rigorous educational program and pass a licensing exam in order to practice, which limits the number of people who can enter the industry. This restriction on entry allows dentists to maintain prices above competitive levels.

Question 10

Consider the case of a natural monopoly with falling long -run average costs.If regulation sets the price equal to marginal cost,then

Accepted Answer

In a natural monopoly with falling long-run average costs, setting the price equal to marginal cost would result in the firm operating at a loss. This is because the average cost would be higher than the marginal cost, and thus the price set at marginal cost would not cover the average costs of production, leading to losses for the firm.

Question 11

Monopoly is allocatively inefficient because

Accepted Answer

Allocative efficiency occurs when price equals marginal cost. In a monopoly, the price is set higher than the marginal cost of production, leading to underproduction and a deadweight loss to society. Therefore, choice A is correct.

Question 12

Suppose your municipality charges your household a flat fee of $100 per year plus $2 per cubic metre of water used.This pricing policy is an example of

Accepted Answer

The pricing policy described is a two-part tariff, which involves a fixed fee (i.e. $100 per year) plus a variable fee based on usage (i.e. $2 per cubic metre of water used). This is a common pricing strategy used by utilities such as water, gas, and electricity providers. It allows the provider to cover their fixed costs while still generating revenue from variable usage fees.

Question 13

If a perfectly competitive industry was suddenly monopolized without any change in cost conditions,

Accepted Answer

In a perfectly competitive industry, firms are price takers and produce output where MC=MR. Therefore, the market price is determined by the intersection of industry supply and demand. If a monopolist were to suddenly gain control of the industry, they would have the ability to restrict output and raise prices above the competitive level in order to maximize profits. This would cause a decrease in the quantity produced compared to the competitive level and an increase in the market price.

Question 14

One method of regulating a natural monopoly is known as average -cost pricing.Using this method,the regulator requires that the price be set equal to

Accepted Answer

Average-cost pricing aims to set the price equal to the long-run average cost of production, which includes both fixed and variable costs. This helps ensure that the firm earns a fair return on investment while also preventing it from exploiting its market power to charge excessively high prices. Setting prices based on internal cost, marginal cost, average variable cost, or average fixed cost would not be as effective in regulating a natural monopoly.

Question 15

Suppose a cell-phone service provider has monopoly rights for a geographical region and is earning monopoly profits.If the government then imposes a lump-sum tax (i.e.,a tax that is independent of the level output)of $X on this firm,the effect is

Accepted Answer

A lump-sum tax does not affect the marginal cost of production but increases the firm's average total costs. The firm's profit decreases by the amount of the tax, $X, but its output and price decisions remain unchanged because marginal costs, which determine these decisions in monopoly pricing, are unaffected.

Question 16

Consider the efficiency of various market structures.In the absence of other market failures,allocative efficiency is achieved only under perfect competition because only this market structure results in

Accepted Answer

Allocative efficiency is achieved when price (P) is equal to marginal cost (MC), which only occurs in perfect competition.

Question 17

If average-cost pricing is imposed on a falling-cost natural monopoly,the result will be

Accepted Answer

Average-cost pricing on a falling-cost natural monopoly results in zero economic profit because the firm is allowed to cover all its costs, including a normal return on investment, but it does not earn above-normal profits.

Question 18

A regulated monopoly that faces rising long-run costs (at its current level of output)and which is forced to price its output at average cost will provide

Accepted Answer

The answer of A regulated monopoly that faces rising long-run...

Question 19

In general,which of the following statements guides policymakers with respect to a natural monopoly? The firm

Accepted Answer

Natural monopolies arise when it is more efficient for one firm to produce a good or service than for multiple firms to do so. However, without regulation, the monopolist may charge a higher price and produce a lower quantity than would be socially optimal. Therefore, policymakers typically regulate natural monopolies in order to reduce allocative inefficiency and promote consumer welfare.

Question 20

If a regulatory agency imposes a lump-sum tax on a monopolist (i.e.,a tax that is independent of the level of output)it will reduce the firmʹs profits because the tax increases

Accepted Answer

A lump-sum tax increases the firm's total costs without affecting the marginal cost (MC) or the firm's production decisions, thus impacting long-run average cost (LRAC) but not altering price or output levels.

Quiz 12: Economic Efficiency and Public Policy