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1. The distribution of natural gas for residential use is often a natural monopoly. The diagram below shows the cost and revenue curves for a profit-maximizing gas distribution firm. Price is given in dollars per cubic metre (m3)and quantity is the number of cubic metres per month.

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a. Explain how you know that this firm is a natural monopoly.

 

b. If the firm is unregulated, what do you predict its price, output, and profits to be?

 

c. If the firm is regulated and required to use marginal-cost pricing, what is the predicted price, output, and profits?

 

d. If the firm is regulated and required to use average-cost pricing, what is the predicted price, output, and profits?

 

e. What is an important problem with the regulatory policy in part (c)?

 

f. What is an important problem with the regulatory policy in part (d)?

 

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