380 PART • Market Structure and Competitive Strategy $/Q MR MC Pm Marginal revenue curve when price is regulated to be no higher than P1 P1 P2 ϭ Pc AC P3 P4 AR Qm Q1 Q Qc Q3′ Quantity F IGURE 10.11 PRICE REGULATION If left alone, a monopolist produces Qm and charges Pm When the government imposes a price ceiling of P1 the firm’s average and marginal revenue are constant and equal to P1 for output levels up to Q1 For larger output levels, the original average and marginal revenue curves apply The new marginal revenue curve is, therefore, the dark purple line, which intersects the marginal cost curve at Q1 When price is lowered to Pc , at the point where marginal cost intersects average revenue, output increases to its maximum Qc This is the output that would be produced by a competitive industry Lowering price further, to P3, reduces output to Q3 and causes a shortage, Q3= - Q3 price even more—say, to P3—results in a reduction in quantity This reduction is equivalent to imposing a price ceiling on a competitive industry A shortage develops, (Q3= - Q3), in addition to the deadweight loss from regulation As the price is lowered further, the quantity produced continues to fall and the shortage grows Finally, if the price is lowered below P4, the minimum average cost, the firm loses money and goes out of business Natural Monopoly • natural monopoly Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms Price regulation is most often used for natural monopolies, such as local utility companies A natural monopoly is a firm that can produce the entire output of the market at a cost that is lower than what it would be if there were several firms If a firm is a natural monopoly, it is more efficient to let it serve the entire market rather than have several firms compete A natural monopoly usually arises when there are strong economies of scale, as illustrated in Figure 10.12 If the firm represented by the figure was broken up into two competing firms, each supplying half the market, the average cost for each would be higher than the cost incurred by the original monopoly