city in a developing country does not have a provider of water and sanitation services, leading to poor health outcomes for its citizens. A firm is considering entering that market. The cost curve is C(g) = 10 + 2q, and the inverse demand is P(g) = 10-q. The government of that city knows that, because of the high fixed cost to operate in this market, any entrant is likely to become a monopolist. Thus, they decide to implement the following regulation: the firm is not allowed to choose a price above an upper limit of p (which the government chooses and sets in the law before the firm decides to enter). There will be no transfers between the government and the firm. Assume that the firm only enters the market if it can get profits of at least zero, given the government's choice of p. Suppose that the government's goal is to maximize consumer surplus. Which of the following statements is the most correct? The government needs to set p = 2, because it's the marginal cost. That eliminates the deadweight loss, thus maximizing consumer surplus. The government needs to set p below the marginal cost. Then, part of the producer surplus will become consumer surplus, achieving the government's goal. The p that maximizes consumer surplus is above marginal cost. Consumer surplus will be zero regardless of the government's choice of p, because it is never optimal for the firm to enter this market. The firm will enter the market regardless of p, and the value of p does not affect consumer surplus.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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A city in a developing country does not have a provider of water and sanitation services, leading to poor health outcomes for its citizens. A firm is considering entering that
market. The cost curve is C(g) = 10 + 2q, and the inverse demand is P(g) = 10-q. The
government of that city knows that, because of the high fixed cost to operate in this market, any entrant is likely to become a monopolist. Thus, they decide to implement the following regulation: the firm is not allowed to choose a price above an upper limit of p (which the government chooses and sets in the law before the firm decides to enter).
There will be no transfers between the government and the firm.
Assume that the firm only enters the market if it can get profits of at least zero, given the government's choice of p. Suppose that the government's goal is to maximize consumer surplus. Which of the following statements is the most correct?

The government needs to set p = 2, because it's the marginal cost. That eliminates
the deadweight loss, thus maximizing consumer surplus.
The government needs to set p below the marginal cost. Then, part of the producer surplus will become consumer surplus, achieving the government's goal.
The p that maximizes consumer surplus is above marginal cost.
Consumer surplus will be zero regardless of the government's choice of p, because it is never optimal for the firm to enter this market.
The firm will enter the market regardless of p, and the value of p does not affect consumer surplus.

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