The graph to the right shows the relevant curves for a natural monopoly. The two
ID: 1201121 • Letter: T
Question
The graph to the right shows the relevant curves for a natural monopoly. The two AC curves show average cost before and after the discovery of a new process that reduces costs. Suppose that the firm is regulated using the cost-plus, or fair-return price, methed and that regulators can accurately estimate the firm's costs of production. When the firm's average cost function is represented by the curve AC 1, what is the firm's economic profit? After the firm discovers the above mentioned cost savings and is now represented by AC 2, what is the firm's economic profit? Given the profit identified with each cost structure, the firm:Explanation / Answer
Producer choses the level of output where MR = MC
In this graph, MR intersects MC at Quantity = 4.5
Economic profit with cost curve AC1 = Total revenue - total cost ( AC * Q)
= P*Q - AC * Q = 5.5*4.5 - 3.7 * 4.5 = (4.5) * (1.8) = $8.1
Economic profit with cost curve AC2 = 5.5 * 4.5 - 2 * 4.5 = (4.5) * (3.5) = $15.75
The firm identified cost saving measures that derive down costs.
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