Multiple Choice
In a competitive market with identical firms, what happens to the long-run economic profit of each firm?
92
views
3. The Market Forces of Supply and Demand
Competitive Markets
Multiple Choice
In the context of competitive markets, what outcome is most likely when the graph shows the case of an unregulated natural monopolist?
A
The monopolist sets price above marginal cost, resulting in deadweight loss.
B
The market achieves allocative efficiency without government intervention.
C
The monopolist produces at the socially optimal output where price equals marginal cost.
D
The monopolist faces perfectly elastic demand and earns zero economic profit.
Verified step by step guidance1
Step 1: Understand the nature of a natural monopoly. A natural monopoly occurs when a single firm can supply the entire market at a lower cost than multiple firms due to economies of scale, meaning the average cost decreases as output increases over the relevant range.
Step 2: Recognize that in an unregulated natural monopoly, the monopolist maximizes profit by producing where marginal revenue (MR) equals marginal cost (MC), but since the demand curve is downward sloping, the price (P) set by the monopolist is above MC.
Step 3: Recall that allocative efficiency occurs when price equals marginal cost (\(P = MC\)), which maximizes total surplus in the market. However, because the monopolist sets \(P > MC\), allocative efficiency is not achieved.
Step 4: Identify that setting price above marginal cost leads to a deadweight loss, which is the loss of total surplus due to underproduction compared to the socially optimal output level where \(P = MC\).
Step 5: Conclude that without government intervention, the natural monopolist will set a price above marginal cost, resulting in deadweight loss, and the market will not achieve allocative efficiency.
Related Videos
Related Practice
