Ace Monopoly has a widget plant in Eastville that is the sole supplier of widgets in Eastville, and it has an identical plant in Westville that is the sole supplier in Westville. There is no trade between Eastville and Westville, so the monopoly status of each plant is secure. The Widget Regulatory Administration (WRA) regulates Ace. The following table shows the total costs associated with different levels of output in each (identical) plant, and it also shows the maximum price that can be charged for different quantities of output in each city.

Maximum Price that Can be Charged

Output Total Cost in Eastville in Westville

4,000 $68,000 $18.00 $30.00

4,500 74,250 16.50 27.00

5,000 80,000 15.00 24.00

5,500 85,250 13.50 21.00

6,000 90,000 12.00 18.00

6,500 94,250 10.50 15.00

7,000 98,000 9.00 12.00

7,500 101,250 7.50 9.00

8,000 104,000 6.00 6.00

8,500 106,250 4.50 3.00

9,000 108,000 3.00 0.00

a) The WRA initially takes the view that the price of widgets should be the same in both cities, and that it should be just sufficient to cover Ace's marginal costs. What would be the price and output of widgets in each city, under this rule?

b) On what grounds does Ace protest to WRA? (Note what Ace's profits would be.)

c) WRA relents, and allows Ace to set a price in each city equal to its average cost in that city. What will the price and output be in each city? Explain why there has been a bigger reduction in output in one city than in the other.

d) Show how the rule adopted in c) has created inefficiency in the widget market. In which city is the inefficiency more serious?

e) Ace has now come to an agreement with WRA such that it is guaranteed not to have economic losses. What would you predict will happen to its cost schedule over time? Is there anything that WRA can do to prevent this?