Question

A certain town in the Midwest obtains all of its electricity from one company, Northstar Electric. Although the company is a monopoly, it is owned by the citizens of the town, all of whom split the profits equally at the end of each year. The CEO of the company claims that because all of the profits will be given back to the citizens, it makes economic sense to charge a monopoly price for electricity. True or false? Explain.

Short answer

False. Charging monopoly prices in this scenario doesn't necessarily make economic sense as it could lead to disparity among citizens depending on their usage of electricity.

Step-by-step solution

Understanding the situation

In this situation, Northstar Electric is a monopoly, owned by the residents of a particular town. At the end of the year, they distribute the profits equally among the citizens. The CEO opines that charging monopoly prices is economically beneficial since the proceeds are shared among the inhabitants.

Dictate the definition of a Monopoly

According to economics, a monopoly occurs when a company is the only supplier of a specific product or service in the market. The company can then dictate its prices, known as monopoly pricing, which is typically higher than if there were competition.

Evaluating the CEO’s claim

The CEO's argument is that since the profit returns to the citizens, the higher costs won't impact them. But what the CEO ignores is the fact that not all citizens consume the same amount of electricity. Some might use less, some more. The ones using less will pay more relative to their usage and receive the same share of profit, therefore effectively losing money. On the contrary, the ones who use more will benefit disproportionately. This creates a form of inequality amongst the citizens.

Conclusion

Consequently, it does not necessarily make economic sense to charge monopoly prices in this situation. An adjustment in prices to reflect the actual consumption would likely be more economically reasonable and fair to all citizens, maximizing social welfare.