Monday, November 20, 2006

Quiz 8 - Question 10 explanation

#10 is the question that most people got wrong. (Answer D), with C being the main answer people who got it wrong gave.

A and B do not make sense for a natural monopoly so the question is whether C or D is the better answer. C asks you whether a company that owns a large portion of a countries natural resources could be considered a natural monopolist. D asks you whether an industry with extensive economies of scale could be considered a natural monopolist.

C cannot be a natural monopolist because a natural monopoly is both inevitable and desirable. That is, it is not inevitable that a Diamond Company controls all the worlds diamonds and then exists as a natural monopoly. The same with Wheat, grain, or oil. You don't have to have one company running the business, it just ended up occuring. The government can step in and break up this company without undo social harm.

This is not the case with D because the large economies of scale mean that any breakup of the company raises ATC (remember the graph). Higher costs mean higher prices. Higher prices lead to less quantity demanded (remember the demand curve). So breaking up the monopolist is undesirable. In other words, if you get your electricity from LIPA or Con Edison, you do not want that company broken up because smaller companies cannot offer you electricity as cheaply as the one company you currently have.

No comments: