Prior to the late \(1990 \mathrm{~s}\), the same company that generated your electricity also distributed it to you over high-voltage lines. Since then, 16 states and the District of Columbia have begun separating the generation from the distribution of electricity, allowing competition between electricity generators and between electricity distributors. a. Assume that the market for electricity distribution was and remains a natural monopoly. Use a graph to illustrate the market for electricity distribution if the government sets price equal to average total cost. b. Assume that deregulation of electricity generation creates a perfectly competitive market. Also assume that electricity generation does not exhibit the characteristics of a natural monopoly. Use a graph to illustrate the cost curves in the long-run equilibrium for an individual firm in this industry.

To address this part, we first need to understand how a natural monopoly behaves. A natural monopoly is a type of market structure in which a single firm can produce the entire market demand at a lower cost than multiple firms. This is generally due to high fixed costs or economies of scale that give the single firm an advantage in supplying the market. In the case of electricity distribution, this could be due to the extensive infrastructure required for high voltage lines. 1. Draw a graph with three axes: the vertical axis represents both price and cost (P = \(c\)), the horizontal axis represents quantity (Q), and the third axis represents the number of firms in the market (n). 2. Draw the average total cost (ATC) curve. This curve is generally U-shaped and slopes downward at first (due to economies of scale) and then slopes upward (due to diseconomies of scale). 3. Since this is a natural monopoly under government regulation, the price will be set where it is equal to average total cost. Draw a horizontal line at this price level, which intersects the ATC curve. 4. The point of intersection between the horizontal line and the ATC curve represents the quantity of electricity distributed by the monopolist when price is set equal to average total cost. 5. Mark the point on the horizontal axis corresponding to the determined quantity, indicating the quantity distributed under government regulation. By setting the price equal to the average total cost, the government ensures that the natural monopolist does not make excessive profits but still covers all costs, including a reasonable return on investment.

In this part, we analyze the long-run equilibrium for an individual firm in the electricity generation industry, which results from the deregulation and does not exhibit the characteristics of a natural monopoly. Since this market is perfectly competitive, the firms will earn zero economic profits in the long-run equilibrium. 1. Draw a graph with two axes: the vertical axis represents price (P) and cost (C), and the horizontal axis represents quantity (Q). 2. Draw the individual firm's cost curves, including average total cost (ATC), average variable cost (AVC), and marginal cost (MC). Remember that ATC and AVC are U-shaped, while MC curve is also U-shaped and intersects both the ATC and AVC at their respective minimum points. 3. In a perfectly competitive market, the price is determined by the market supply and demand, and each firm takes this price as given. Draw the demand curve faced by the individual firm as a horizontal line at the given market price. 4. The long-run equilibrium for a firm in a perfectly competitive market occurs when price is equal to the minimum point on the individual firm's ATC curve. Find the point of intersection between the demand curve and the ATC curve, which represents the equilibrium quantity. 5. Draw a vertical line from the equilibrium quantity point to the horizontal axis, indicating the quantity produced by the firm in the long-run equilibrium. In the long-run, the firm earns zero economic profits as the price equals the minimum average total cost in a perfectly competitive market. This equilibrium illustrates the effect of deregulating the electricity generation industry and introducing competition, leading to more efficient outcomes for the firms involved.