Question

When it comes to regulating natural monopolies, if this natural monopoly were left alone and not regulated, it would follow a normal approach to maximizing profits. If this were the case, what profit-maximizing price and quantity would this natural monopoly choose?

Answer 1

If a natural monopoly is left unregulated, it would produce at quantity where Marginal Revenue is equal to Marginal Cost. (MR= MC). This will determine the profit maximizing Quantity.

Corresponding to this Quantity, the Monopolist will look at the market demand to know what is the price to be charged for this quantity. That will become the profit maximizing price.

The difference between the (profit max) price and cost (AC) at this quantity will determine the per unit profit for the monopolist.

For example in this diagram given below, MR=MC at Qm.

So Qm= profit maximizing quantity.

Corresponding to this Quantity, price is Pm from the demand curve.

So Pm= profit maximizing price.

When Q= Qm, Average Cost (AC) = C

So maximum profit = Qm(Pm - C)

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