Answer to Question #274130 in Microeconomics for Moncaufr

Question

1. Can a firm be a natural monopoly if it has a U-shaped average cost curve? Why or why not?

2. Can a firm operating in the upward-sloping portion of its average cost curve be a natural monopoly? Explain.

3. In the Application "The Botox Patent Monopoly," what would happen to the equilibrium price and quantity if the government had collected a specific tax of $75 per vial of Botox? What welfare effects would such a tax have?

Answer 1

Solution:

1.). Yes, a firm can be a natural monopoly if it has a U-shaped average cost curve.

This is because costs increase at a decreasing rate, such that both marginal and average costs decline. However, once diminishing returns set in, costs begin to increase at an increasing rate; the marginal costs begin to rise, and the total cost increases at an increasing rate, which causes the average cost to begin rising and yields the U-shaped average cost curve.

 

2.). Yes, a firm can only be a natural monopoly if it has a cost advantage over other potential firms. This is because a natural monopoly occurs when the most efficient number of firms in the industry is one.

3.). The specific tax of $75 will cause the equilibrium price to increase since the price of Botox will be increased by the additional taxes. On the other hand, the equilibrium quantity will decrease, since the higher prices will result in the quantity demanded for Botox to go down.

The specific tax will result in a welfare loss of taxation. This refers to a decrease in economic and social well-being caused by the imposition of a new tax. It is the total cost incurred by the process of transferring purchasing power from taxpayers to the taxing authority.