Question

3. In 1954, the U.S. Supreme Court ruled natural gas wellhead prices should be regulated in addition to the ongoing pipeline regulation. Each producer received a rate of return based on their cost of service. Natural gas producers had natural monopoly characteristics. A typical monopoly operates at a quantity where MR = MC and sets price based on the demand curve at that quantity. On the graph below, this is represented by point M, with corresponding price and quantity of Pm and Qm. $/Q M PM --- - - - - -LRATC -- LRMC MR D Qм QNG (mcs)

Answer 1

a. Social optimum point is where long run marginal cos (LRMC) touches demand curve, this price should be charged which is lower than currently Pm and Q quantity is higher than current quantity Qm. At this point form will be producing more at less price and consumers will be benefitted. This approach is called marginal cost pricing approach. This leads to proper allocation of resources. Monopolist does not agree as price is less than average total costs.

b. Fair return will force monopolist to charge price equal to point where long run average total cost curve touches demand curve. This is called average cost pricing or fair return pricing.This price avoids losses and is also less than market price. Monoplist does not agree as it is not lowest average cost point.

c. It is clear that fair return pricing offers to cover average total costs and avoids loss.

d. As mentioned in point b this price is not the lowest average total cost. This also leads to inefficiency as firm is offered to cover the costs. Another point is that regulated monopoly will survive as monopoly.