Question: Consider a natural monopoly with declining average costs summarized by the equation AC = 16/Q + 1, where AC is in dollars and Q is

Consider a natural monopoly with declining average costs summarized by the equation AC = 16/Q + 1, where AC is in dollars and Q is in millions of units. (The total cost function is C = 16 + Q.) Demand for the natural monopolist’s service is given by the inverse demand equation P = 11 + Q.

a. Determine the price and output of the unregulated natural monopolist.

b. Suppose a regulator institutes average-cost pricing. What is the appropriate price and quantity?

c. Answer part (b) assuming the regulator institutes marginal-cost pricing. What is the enterprise’s deficit per unit of output? How might this deficit be made up?

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