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Question from Past Microeconomics Qualifying ExamEdit

Fall 1999- Section I, Question three, George Mason University

True, False, Uncertain. Determine whether or not each of the following statements are true or false. Explain your reasoning briefly in a paragraph or two. (The explanation is often more important than the answer given). Include a carefully labeled diagram or game matrix if it helps to clarify your answer.


The case for regulating monopoly is strongest in the case of “natural monopoly” in cases where price discrimination is impossible.

AnswerEdit

True, A market that is most cheaply served by a single firm is called a natural monopoly (Frank 397). A “natural monopoly” occurs when the long run AC curve is declining throughout the relevant range. Because the LRAC curve is declining thought, there is a natural tendency for only one firm to serve the market. If two firms attempt to serve the market, the larger firm will have a significant cost advantage and be able to force its rival out of business. The natural monopoly makes the strongest case for regulation because it is the monopoly where it is least likely that competition will eventually arise.

In a natural monopoly situation, an unregulated firm would still produce where MR = MC. Because perfect price discrimination is impossible, there would be a deadweight loss to society. Because AC > MC, a regulated price set by the government would still exceed the perfectly competitive price; however, the regulatory solution is an improvement to the unregulated solution leading to an increase in output, a decrease in price, and a decrease in the deadweight loss to society.

True, A “natural monopoly” occurs when the AC curve is declining in the relevant range. In this case, the unregulated monopoly would still produce where MR = MC. Since AC > MC, the price set by regulators exceeds the perfectly competitive price, but the regulatory solution is an improvement leading to an increase in output.


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