The rail system in Metropolis is a natural monopoly.If the government regulates the system by setting the fare equal to marginal cost, which of the following will be true?
A)The managers of the rail system will be allowed to adjust marginal cost so that they can get a normal rate of return on capital.
B)The managers of the rail system will be allowed to adjust marginal cost so that they can get a fair profit.
C)The rail system will earn economic profit at that fare.
D)If the government doesn't give the rail system a subsidy to supplement revenue from fares, the system will face continuous economic losses.
E)If the government doesn't give the rail system a subsidy to supplement revenue from fares, fare increases will push marginal cost upward.

Question

Quizplus · Accepted Answer

A natural monopoly is characterized by high fixed costs and low marginal costs. Setting the fare equal to marginal cost would not allow the rail system to cover its fixed costs and will result in continuous economic losses. Therefore, without a subsidy from the government, the rail system will not be able to operate sustainably. Choice A and B are not valid because allowing the managers to adjust marginal cost for normal rate of return or fair profit would not solve the problem of high fixed costs. Choice C is not valid because the natural monopoly would not earn economic profit at that fare due to high fixed costs. Choice E is not valid because fare increases would not push marginal cost upward since marginal cost remains constant regardless of the fare.

The Rail System in Metropolis Is a Natural Monopoly