Answer to Question #63694 in Microeconomics for Aisha

Question

A firm has a U-shaped average cost curve. The market demand is a downward-sloping straight line.

A). Can this firm ever be a natural monopoly? If not, why not? If so, what conditions must be met for it to be a natural monopoly? (10 pts)
B). Show the equilibrium price, quantity, and profit for this monopoly equilibrium. (7 pts)

Firm 1 is initially a monopoly. Then, a competitive fringe enters the market. The fringe supply is horizontal at p* (a price that is above Firm 1's minimum average cost). Show that the dominant firm-competitive fringe equilibrium price, p*, is less than the original monopoly equilibrium price, p (10 pts).
Also show how much the dominant produces, Qd, and how much the fringe produces, Qf, in the new equilibrium (7 pts).

Answer 1

A firm has a U-shaped average cost curve. The market demand is a downward-sloping straight line.
A) This firm can be a natural monopoly, because natural monopolies have a U-shaped average cost curve and market demand as a downward-sloping straight line. The conditions to be met for it to be a natural monopoly are that natural monopoly has a high fixed cost for a product that does not depend on output, but its marginal cost of producing one more good is roughly constant, and small.
B) The equilibrium quantity is in the point, for which MR = MC, equilibrium price is on the demand curve at this quantity, and profit for this monopoly equilibrium can be calculated as TP = (P - ATC)*Q.
Firm 1 is initially a monopoly. Then, a competitive fringe enters the market. The fringe supply is horizontal at p* (a price that is above Firm 1's minimum average cost). Then the dominant firm-competitive fringe equilibrium price, p*, is less than the original monopoly equilibrium price, because it is at the point, for which MC = D. The dominant produces less and the fringe produces more.