Download The Electricity Generating Industry is characterized by economies

The Electricity Generating Industry is characterized by economies-of-scale due to high fixed costs, e.g, the
costs of a dam, coal turbine, or nuclear power plant, and low variable costs, e.g., transmission and
distribution lines to the houses/businesses served. Consequently, average long-run (where capital, or size
of the plant) decrease over the relevant range of expected demand.
Below is an example of “representative” LRAC and SRAC average cost curve. The x-axis is in Megawatts
(amount of electricity produced). Suppose that quantity demanded will be 200 MW and that with
competition, there will initially be four firms each generating 50 MW of load.
A) On which SRAC will electricity produced by each firm?
B) Suppose that the state government decides to create a natural monopoly for electricity, i.e.,
licensing only 1 firm to generate electricity. On which SRAC will electricity produced by the
single firm?
C) Will the Average Cost of electricity be greater or less when 1 single firm has a “license” to be the
sole provider the state?
The figure above provides the cost for a generating firm when it has been granted a “natural” monopoly
in the production of electricity
A) Suppose that government places no restrictions on the price that the firm can charge. What price
and output will the firm choose to operate at?
B) What type of market structure is the firm operating in with its choice of pricing strategy?
C) Suppose that the government requires the firm to set its price to cover its Average Cost and set
rates such that Average Revenue will just exactly cover its Average Costs. What price and output
will the firm choose to operate at?
D) Will this be new rate (Avg Cost = Avg Rev) be more allocatively (deadweight loss) and/or
productively (lower Avg Cost) efficient than in (A)?
E) Is (D) completely economically efficient? (I.e., no deadweight loss)
F) What output level would be economically efficient?
G) What would be the price that the firm could charge customers in order to have them consume
(quantity demanded) at the efficient amount?
H) What would be the average price that the firm could charge for the efficient level of output?
What are the firm’s average costs at the efficient level? Would the firm make a profit at that price
and output level?
I) How could the government “incent” the firm to produce the efficient level of output?