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Consider the market for water in a small town in the Old West
Consider the market for water in a small town in the Old West. Assume that the only source of water is the underground aquifer that lies directly below the town. Wells are used to supply water to the entire town.
Suppose only one resident owns all the wells in town. Which of the following statements about the market for water is most likely accurate?
a. The price of a gallon of water will be driven to equal its marginal cost.
b. The price of a gallon of water will exceed its marginal cost.
c. Since water is a necessity of life, there will be no decline in the quantity of water consumed, regardless of how high the price is raised.
d. The seller will be able to earn unlimited profit.
Expert Solution
- The correct option is b. The price of a gallon of water will exceed its marginal cost .
Since the single seller will act as a monopolist; the quantity supplied would be decided at the level where marginal revenue is equal to the marginal cost. The price of each gallon of water will be charged on the demand or average revenue curve, which lies above the marginal cost.
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