Government Intervention

Government Intervention with Natural Monopolies

The government can try to correct a natural monopoly in 3 ways.

Natural Monopoly Regulation

A natural monopoly is one in which the ATC (Average Total Cost) is always falling. This means that the MC (Marginal Cost) must lie ________ the ATC.

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 ________ units and a price of ________.
• However, at this output level, the ATC is ________ which means the profit is ________ (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 = ________
• 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 ________ and a yearly membership fee of ________ .

3. Average Cost Pricing

• In average cost pricing the Price = ATC
• In the diagram above, this would be at an output of ________ units and a price of ________.
• However, at this output since Price is ________ to MC it is not allocatively efficient.