AP_Krugman_Textbook

module 77 Public Policy to Promote Competition 759

Section 14 Market Failure and the Role of Government

2. The FYI in this module discusses the possibility that regulators
   set prices for wind energy on the basis of average total cost.
   Explain why policymakers who don’t want to pay subsidies

would choose average cost pricing over marginal cost

pricing in the market for wind energy.

Tackle the Test: Multiple-Choice Questions

1. The Sherman Antitrust Act of 1890 sought to do which of the
   following?
   a. break up existing monopolies
   b. prevent the creation of new monopolies
   c. stop monopoly behavior engaged in by trusts
   d. respond to the increasing power of trusts in the economy
   e. all of the above


2. A natural monopoly exists when, over the relevant range,
   increasing the output level results in a lower
   a. total cost.
   b. average total cost.
   c. average variable cost.
   d. average fixed cost.
   e. marginal cost.


3. Which of the following is the most common policy approach to
   a natural monopoly?
   a. public ownership
   b. price regulation
   c. quantity regulation
   d. quality regulation
   e. a breakup of the monopoly into smaller firms

For questions 4 and 5, refer to the graph provided.

4. Without government intervention, a monopolist will
   produce and charge.
   a. Q 3 ,P 3
   b.Q 2 ,P 4
   c. Q 2 ,P 1
   d.Q 1 ,P 3
   e. Q 1 ,P 2


5. The lowest regulated price the government could expect this
   monopolist to maintain in the long run is
   a. P 1.
   b.P 2.
   c. P 3.
   d.P 4.
   e. P 5.

ATC

MR D

MC

P 1

P 2

P 3

P 4

P 5

Q 1 Q 2 Q 3 Q 4 Quantity

Price,

cost per

unit

Tackle the Test: Free-Response Questions

1. a. Draw a correctly labeled graph showing a natural monopoly.
   On your graph, label the price and quantity the monopoly
   will choose if unregulated as PUand QU.
   b. On the same graph, shade in and label consumer surplus
   and the firm’s profit in the absence of regulation.

c. On the same graph, label the lowest price that regulators

could expect the monopoly to maintain in the long run as

PRand the resulting quantity as QR.

d. What happens to the size of consumer surplus when the

firm is required to charge PRrather than PU? What happens

to the firm’s profit?