Question B3 (25 marks)

1. "Consider a single-productpublicutilitythatisthesolefirmoperatinginanindustry that is a natural monopoly. Setting the price charged by such a public utility equal to marginal cost and covering any consequent loss through a subsidy that is funded by imposing taxes in other parts of the economy must be superior (from a Kaldor- Hicks efficiency perspective) to setting that price equal to average cost." Is this statement true, false, or ambiguous? Justify your answer. (5 marks.)
2. Consider a two-product monopolist whose (total) production costs in dollars is given by the function

C(q1, q2) =F+ (0.1)q1+ (0.15)q2,

whereq1is its output of commodity one andq2is its output of commodity two. Suppose that the monopolist must charge a linear (constant per-unit) price for each commodity. The monopolist is currently charging a price of $0.30 per unit for commodity one and a price of $0.60 per unit for commodity two. At these prices, the own-price elasticity of demand for commodity one is equal to0.1 and the own- price elasticity of demand for commodity two is equal to0.5. The demands for two commodities are independent, so that there are no cross-price effects.

1. (a)Is it possible for the prices that the monopolist has chosen to maximise its profits? Justify your answer. (5 marks.)
2. (b)Suppose that the prices that the monopolist chose above were actually man- dated for it by a regulator. Is it possible for these prices to be Ramsey-Boiteux prices, where the minimum profit constraint takes the form of a break-even constraint? Justify your answer. (5 marks.)