Chapter 77, Problem 2CYU

To determine

The reason why policymakers who don’t want to pay subsidies would choose average cost pricing rather than marginal cost pricing in the market for wind energy when the farm involves a high fixed cost.

Explanation of Solution

As the fixed cost is high for the farm and therefore, the farm needs to avoid extra costs and gain at least a normal profit. And, the policymakers who don’t want to pay subsidies would choose average cost pricing rather than marginal cost pricing for wind energy because by using the method of average cost pricing they can guarantee a normal profit for the business but the marginal cost pricing does not guarantee a normal profit. Because this is a natural monopoly business, then, to prevent price-fixing, they will set up a price that would be close to the average cost.

Therefore, for wind energy, policymakers would select average cost pricing.

Economics Concept Introduction

Introduction: Average cost pricing is beneficial for public utilities and this rule ensures the normal profit for the business. And, marginal cost pricing refers to the practice through which price is settled equally to the extra cost of producing an additional unit of product or output.