Download Regulation of Monopoly

Regulation of Monopoly
ABC Ltd. is a pure monopoly supplying water in Leisurecity. It is a municipal firm
and Leisurecity citizens are trying to convince the municipality to reduce the price of water,
because it is too high, while ABC Ltd. is collecting huge profits. The firm says that they need
higher profit in order to accumulate money to invest in infrastructure and improve water
supply in Leisurecity. During this current debate economists and business people argue that
the city is loosing resources (deadweight loss from the monopoly) and a higher price of water
could be accepted if only the monopoly profit is muuuuuuch greater than the deadweight loss
for the society. The city Council decides to hire you to bring evidence that will help them to
make a decision on monopoly pricing.
You are given the following information:
ABC Ltd. demand curve is given by the equation:
P = 100 - 1/4Q
Its marginal revenue is presented by:
MR = 100 -1/2Q
The cost functions of ABC Ltd. are:
MC = 20 + 0.2Q
AC = 50/Q + 20 + 0.1Q
Find the losses for the society of this monopoly and determine the loss of monopoly
profit if the monopoly is regulated by a fixed price, equal to its marginal costs.
In order to facilitate your work, I am giving you a graph (on the next page), presenting the
demand curve, the MR, MC and AC curves. Further, use the following hints:
The loss for the society = loss of consumer surplus + loss of producer surplus.
Finding the losses for the society means finding:
1. loss of consumer surplus = consumer surplus transferred to the monopoly, due to the
higher price;
2. deadweight loss of consumer surplus;
3. deadweight loss of producer surplus;
4. total deadweight loss = 2 + 3, which is the net loss for the society.
Next, find monopoly profit before, and after the regulation and find the loss for the
monopoly. Compare the difference between them to the loss for the society.
(Sorry for the numbers that you will have to deal with, but this is homework. On the
midterm you will have simpler numbers)
100
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250