Question 3 - Policy Analysis Energy has become increasingly less affordable for consumers and firms in recent years and this is especially true for natural gas. Recent surges in gas prices have occurred against a backdrop of rising inflation rates here in Australia and overseas. To curb the surge in gas prices, the Australian government is considering a series of regulatory approaches for gas producers. One proposes a cap on the price of gas and the other, a tax on the 'windfall' profits gas companies have earned as a result of the spike in gas prices. The following 2 questions require you to consider the economic effects these policies will have on the market for gas and the firms that produce gas, respectively. i. The gas industry has strong economies of scale and hence is best illustrated using a diagram for a natural monopoly. A natural monopoly has a constant marginal cost and a downward-sloping average total cost curve. Using a full-labelled diagram, evaluate how a cap on the price of gas would work to address rising gas prices. Show the effects of a price cap on the firm's output and economic profit. Discuss who benefits and who loses from this policy approach. In your analysis, you should evaluate the effectiveness of this policy approach and consider any unintended consequences of this policy. 2 (8 marks) ii. A windfall tax will increase the monopoly's fixed cost, as this tax can be seen as a fixed cost. Draw a full-labelled diagram of a natural monopoly firm earning an economic profit. Show the effects of a tax imposed on the economic profits these firms earn. Specifically, the firm's profit-maximising price and output, consumer and producer surplus and deadweight loss.