West Coast Gas, Inc, is a natural gas supplier. The firm faces the demand schedule shown in the table above and cannot price discriminate
The company's fixed cost is $1,000 per month and its marginal cost is constant at $10 per thousand of cubic feet. The government imposes a marginal cost pricing rule on the company. a) What is the price of natural gas supplied by West Coast Gas? How many cubic feet does the company sell? What is the firm's economic profit per month? b) How does the regulation affect total surplus? c) Is the regulation in the social interest? Explain.
a) Marginal cost pricing regulation sets the price equal to marginal cost, which is determined where the marginal cost curve intersects the demand curve. So the price is $10 per thousand cubic feet. At this price, the company sells 80,000 cubic feet of gas. The average total cost at this level of output is $22.50 per thousand cubic feet, so the company's economic profit per thousand cubic feet of natural gas is $10 - $22.50 = -$12.50 per thousand cubic feet, that is, the company incurs an economic loss of $12.50 per thousand cubic feet. The company produces 80,000 cubic feet, so its total economic loss is -$12.50 × 80,000 = -$1,000,000 per month. West Coast Gas incurs an economic loss of $1 million per month.
b) If West Coast Gas is not regulated, the company maximizes its profit by producing 40,000 cubic feet of gas per month and charging $50 per thousand cubic feet. In this case, the consumer surplus is ($90 - $50 ) × 40,000/2 = $800,000 and the producer surplus is ($50 - $10 ) × 40,000 = $1,600,000. The total surplus is $800,000 + $1,600,000 = $2,400,000. With the marginal cost pricing, the total surplus equals the consumer surplus, which is ($90 - $10 ) × 80,000/2 = $3,200,000. So the regulation increases total surplus by $800,000.
c) With no regulation, the marginal benefit ($50 ) exceeds the marginal cost ($10 ), the output produced is below the efficient level and the deadweight loss is $800,000 per month. With the regulation, MSB = MSC, so the output level is efficient and total surplus is maximized. The regulation is in the social interest.
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?
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