1 Government production Should the government produce as a monopolist or try to act like a competitive firm?

2 Say the demand for water in a community is Q = 50 –2P. In inverse form we have P = Q. If the total cost of production is TC = Q, then marginal cost is of a special form, MC = 10 (a constant). We have seen the competitive solution is efficient and occurs where P = MC. So we have Q = 10, or Q = 30 and P = 10. P Q MC = P D Consumer surplus =.5(15)(30) = $225. There is no producer surplus when MC is horizontal in a competitive situation.

3 If the government acts as a monopoly it would want to produce where MR = MC and charge the price on the demand curve for the quantity. Since the demand for water in a community is Q = 50 –2P. In inverse form we have P = Q, so MR = 25 – 1Q. MR = MC means 25 – 1Q = 10, or Q = 15 and so P = 17.5 P Q MC = P D Consumer surplus =.5(7.5)(15) = $ Producer surplus =(7.5)(15) = $ MR

4 So, if the government prices as a monopoly the gain to them is $ in surplus, but the loss to the consumer is – 225 = -$ Note the loss to the consumer is what the producer gains, $112.50, and the deadweight loss triangle on the consumer side,.5(7.5)(15) =

5 Note Sometimes in problems we work it makes sense to assume AC = MC = some constant dollar amount. Then we can solve for best Q where P = MC in competition, or MR = MC in Monopoly (and P is found on demand curve). Then profit = (P – AC)Q