Government Intervention

Government Intervention with Natural Monopolies

Natural Monopoly Regulation

1. Marginal Cost Pricing

• Marginal cost pricing is when the business produces at the output where Price = MC (Marginal Cost)
• In the diagram above this would be at an output of

  90

  ---

  units and a price of

  $10

  ---

  .
• However, at this output level, the ATC is

  $12

  ---

  which means the profit is

  (10 - 12) * 90 = -$180

  ---

  (which is a loss).

2. Two Part Tariff

• In a two part tariff the business will produce where Price = MC
• If each good sells at marginal cost then Total Revenue (TR) = Total Variable Cost (TVC). This means the losses are the fixed costs.
• Producer surplus = TR - TVC so in this case producer surplus =

  0

  ---

• The business can charge a one time fee that covers the total fixed costs and then the firm will break even. Example: Sandra owns a gym with a marginal cost of $10 per month per client (water and electricity) and fixed costs of $50,000 per year (rent). If she is expecting 1,000 clients per year, she would charge a monthly fee of

  $10

  ---

  and a yearly membership fee of

  50,000 / 1,000 = $50

  ---

  .

3. Average Cost Pricing

• In average cost pricing the Price = ATC
• In the diagram above, this would be at an output of

  70

  ---

  units and a price of

  $15

  ---

  .
• However, at this output since Price is

  not equal

  ---

  to MC it is not allocatively efficient.

Example: Government Intervention with Natural Monopolies