Deck 18: Natural Monopoly and the Economics of Regulation

Question 1

A monopoly that develops because the cheapest way to produce any given level of output in a market is to have one firm do it is known as a natural monopoly.

Answer 1

True

Question 2

To have the conditions for a natural monopoly, average costs _________________ fall everywhere.

A) need not
B) must
C) must rise, not

Answer 2

need not

Question 3

A market outcome that is optimal given existing constraints in the market but worse than the outcome that would result if those constraints were removed is the third-best result.

Answer 3

False

Question 4

Under the conditions of sustainable monopoly, extra-normal profits will be

A) guaranteed
B) zero
C) greater than zero

Question 5

A sufficient condition for a natural monopoly is to have an average total cost curve that is

A) falling
B) flat
C) increasing

Question 6

The inertia shopping rule states that buyers will buy from the firm that charges the lowest price, but that, if they are already buying from a firm and another firm enters the market and offers a lower price, they give their current firm a chance to meet the entrant's price before shifting their business.

Question 7

Average-cost pricing is to set a price that is equal to the average cost.

Question 8

If a firm can prevent competitors from entering its market, its ATC will ___________ over a ________ amount of output.

A) decline, large
B) decline, small
C) increase, large

Question 9

A natural monopoly that can erect barriers that keep others out of its market is called a(n)

A) sustainable monopoly
B) unnatural monopoly
C) subadditive monopoly

Question 10

To set a price that is equal to the marginal cost is

A) sustainable-cost pricing
B) marginal-cost pricing
C) average-cost pricing

Question 11

If an entrepreneur wants a natural monopoly to be sustainable, the entrepreneur must set a price and quantity at which demand equals average

A) revenue
B) profit
C) cost

Question 12

A subadditive cost function indicates that the cost of producing x units of output, C(x), is less than the cost of producing A units and B units separately where A + B = x.

Question 13

With falling average costs, a monopolist is able to produce in

A) an increasing-cost way
B) the least-cost way
C) the highest-cost way

Question 14

A game defined by the contestable market assumptions is a contestable market entry game.

Question 15

A contestable market is a market that competitors can easily enter and leave because there are no sunk costs.

Question 16

If, for an output of q, a firm's average costs are declining at every level up to that quantity, the firm's natural monopoly is

A) sustainable
B) regulated
C) Both answers are correct

Question 17

Sunk costs are the costs of the variable factors of production.

Question 18

A method of regulation that is designed to encourage efficient production by allowing firms to share in any cost savings they achieve in producing their product is called contestable-rate regulation.

Question 19

Sunk costs are costs of

A) producing sailboats
B) factors that are recoverable
C) factors that are not recoverable because the items have no resale value or alternative use

Question 20

The capital base is the amount of capital of a firm upon which its rate of return is calculated.

Question 21

The Ramsey pricing rule shows that the _______ elastic the demand for a good is, the more its price will _____________ its marginal cost

A) less, fall below
B) more, rise above
C) less, rise above

Question 22

The amount of capital of a firm upon which its rate of return is calculated is known as the

A) rate base
B) tariff rate
C) interest rate

Question 23

The theory of contestable markets falls apart when

A) no harsh economic penalty exists for exiting the market because there are no sunk costs
B) the incumbent firm can react quickly to entry by changing its price
C) the potential competitor can use a hit-and-run entry strategy

Question 24

What does it mean to say that it is a sufficient, but not a necessary condition for a natural monopoly, for average costs to decrease at all level of output?

Question 25

The generalized stand-alone test asks a group or individual community of similar customers to compare the price they are paying for the service with the price they would have to pay if

A) they provided it for themselves
B) the service were provided in perfectly competitive market
C) the service were provided free by nature

Question 26

The Ramsey pricing rule makes it possible to set prices that will cover the common fixed cost of the producer but also minimize the loss of

A) producer surplus
B) consumer surplus
C) labor surplus

Question 27

An auction in which the right to be the exclusive franchisee of a good or service is auctioned by the government is called a

A) winner's curse
B) Demsetz auction
C) common value auction

Question 28

Explain why the inertia shopping rule provides a defensive pricing strategy.

Question 29

Price-cap regulation is a method of regulation that

A) is designed to encourage efficient production
B) allows firms to share in any cost savings they achieve in producing their product
C) Both answers are correct

Question 30

As a government official, you receive complaints from your constituents about the local broadband Internet access monopoly. How will you respond?

Question 31

The subgame perfect Nash equilibrium for the contestable market entry game is the situation in which the incumbent firm sets the

A) average-cost price
B) rate-of-return price
C) marginal-cost price

Question 32

The Ramsey pricing rule indicates that we should continue raising prices proportionately until enough surplus exists to cover the

A) marginal cost of the product with more inelastic demand
B) common fixed cost
C) producer surplus

Question 33

Regulation in which a regulatory commission must allow any firm under its jurisdiction to earn a rate of return for the firm's investors that is sufficient to warrant their keeping their capital investment in the firm is called

A) overregulation
B) rate-of-return regulation
C) insider trading

Question 34

Hit-and-run entry occurs when a

A) runner on base starts running before the batter swings
B) potential entrant monitoring a market sees an opportunity to enter a market and does so, but then exits when the incumbent firm responds
C) competitor monitoring a market sees an opportunity to exit a market and does so

Question 35

What assumptions must be true for the theory of contestable markets to be valid?

Question 36

Common costs are

A) costs that are shared among customers
B) prices that are set equal to average costs
C) Both answers are correct

Question 37

In the study of monopolies, a franchise is

A) the license a government grants to a company that allows it to set up a monopoly
B) the best player on a football team
C) a form of corporate organization used by fast-food restaurants

Question 38

A market outcome that is optimal given existing constraints in the market but worse than the outcome that would result if those constraints were removed is called the

A) subadditive result
B) second-best result
C) extra-normal result

Question 39

There are two formulas that define the Ramsey pricing rule. One uses demand functions at regulated prices and at marginal costs. The uses the elasticities of demand and a measure of the common fixed cost. Write these two formulas.

Question 40

Which regulatory method does not create a moral hazard with respect to cost containment?

A) average-cost pricing
B) rate-of-return regulation
C) price-cap regulation