CFA Practice Question
The most likely objective of government regulation of a natural monopoly is to ______
A. provide incentives for potential competitors to enter the market.
B. reduce the product price to the supplier's average total cost per unit of output.
C. reduce the product price to the supplier's marginal cost per unit of output.
Explanation: Ideally, price regulation of a natural monopoly would improve resource allocation if price was set equal to firms' average total cost per unit of output. The resulting output level would produce zero economic profits for firms. If price was set equal to marginal cost, however, economic losses would occur and the monopolist would not undertake production.
User Contributed Comments 2
| User | Comment |
|---|---|
| marrilynne2 | I guess looking at long run perspective |
| lordutra | This question is flawed. There are two ways to define the prices of a natural monopoly: by setting it to MC or ATC. If setting to ATC, you're crowding out people who could pay the MC and incurring a dead weight, and a good policy would be to give incentives for people who cannot pay the ATC; If setting to MC the company cannot survive, and the government needs to subsidise the company, but you guarantee a fairer price for the population. Both options improve resource allocation actually. In neither option the firm has much incentive to reduce costs. |