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06 04 06 Option 12

Ampstand is a natural monopolist earning economic profits due to high barriers to entry and economies of scale, preventing other firms from entering the market. The government regulates Ampstand's price under a fair-return policy, resulting in a total cost equal to total revenue, a new output quantity of 10 million, and a consumer surplus of $25 million. To achieve socially optimal production, the government would need to impose a price ceiling at the socially optimal price and provide a lump-sum subsidy to eliminate economic losses.

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242 views2 pages

06 04 06 Option 12

Ampstand is a natural monopolist earning economic profits due to high barriers to entry and economies of scale, preventing other firms from entering the market. The government regulates Ampstand's price under a fair-return policy, resulting in a total cost equal to total revenue, a new output quantity of 10 million, and a consumer surplus of $25 million. To achieve socially optimal production, the government would need to impose a price ceiling at the socially optimal price and provide a lump-sum subsidy to eliminate economic losses.

Uploaded by

babyjfgh
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Ellis Lee 1/12/25 Option 1

Ampstand is a natural monopolist earning economic profits.

(a) Draw a graph of Ampstand, labeling the profit-maximizing price Pm, the profit-
maximizing quantity Qm, and the allocatively efficient quantity QSO. Shade the area of
deadweight loss.

Photo is attached.

(b) If Ampstand is earning economic profits, why would other firms not enter the market?
Explain.

Since Ampstand is a natural monopolist, this implies that there are large barriers to entry
and a single firm is better off producing the product at a lower cost than multiple firms.
The natural monopolist is also in economies of scale.

(c) The government decides to regulate Ampstand's price and follows a fair-return policy. On
your graph from part (a), label this price PFR and the new output quantity QFR.

Photo is attached.

(d) If Ampstand’s total revenue at PFR changes to $100 million, what must its total cost be at
this productive quantity?

The total cost must be $100 million since at the fair-return price, the natural monopolist
earns normal economic profits. This is because the long-run average total cost is
equivalent to the price. Therefore, total revenue – total cost must equal 0.

(e) Determine the output quantity from part (d) if PFR is $10. The demand curve intersects the
y-axis at $15. What is the consumer surplus with the government intervention?

The output quantity from part (d) is 10 million.

Calculations - $100 million / $10 = 10 million

The consumer surplus with the government intervention $25 million.

Calculations – ½ ($15-$10) *(10 million) = $25 million

(f) How would the government action in part (c) affect the deadweight loss in Ampstand's
market?

The deadweight loss due to the government action will decrease. This is because the price
is lowered while the quantity is increased, therefore moving the production point closer to
the allocatively efficient point of MC=D.
(g) What would the government have to do to get Ampstand to produce at the socially
optimal quantity and stay in the market in the long run? Explain.

The government would have to impose a price ceiling at the price of MC=D, the socially
optimal price. The government would then have to give the natural monopolist a lump-
sum subsidy in order to eliminate economic losses that would have incurred without
intervention. The price ceiling would force the natural monopolist to produce a quantity
and set a price at the socially optimal point. The lump-sum subsidy would ensure that
only the long run average total cost is decreased in order to eliminate the economic
losses, while still making sure they ensure normal profits to break even.

(h) Wattsit is a small firm that sells a complementary good to Ampstand's product in a
perfectly competitive market. Assuming Wattsit was in long-run equilibrium, illustrate
the short-run effect of the government intervention from part (e) on Wattsit's supply and
demand in a separate graph. If Wattsit earns any economic profit or loss, shade it.

Photo is attached.

(i) What happens to the demand for the inputs in the factor market required to produce
Wattsit's good as a result of the changes in part (h)?

The demand for the inputs in the factor market to produce Wattsit’s good increases due to
the increase in demand for the product in the product market.

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