Pricing at Panamint Valley Gas: A contestable monopoly

Intended for a Principles of Microeconomics course when the monopoly structure is first introduced. The exercise does not use the MR = MC rule.

Teams will complete their calculations and present a best price in 15 - 20 minutes. Graphing the situation will require varying times depending on student's earlier knowledge.

Overview

Teams use cost and revenue data for a contestable monopoly,a gas station in Panamint Valley, California, 50 miles from the nearest gas station. In this way students practice deriving profit maximization based on variable and fixed cost data and a demand curve. Students learn that a monopoly's profit maximizing price is not the highest that any customer will pay. As a follow-on, students can graph their results.

Expected Student Learning Outcomes

Students will be able to apply prior understanding of fixed costs, variable costs, the demand curve, and profit calculation. Students will appreciate the pressure on a monopoly to set prices. Students should be able to explain why this gas station is a monopoly (geographic isolation) and why it is not subject to antitrust rules (it is a contestable monopoly.)

Information Given to Students

Your team runs a gas station in Panamint Valley, California, an isolated small town on the way to Death Valley National Park. The nearest other gas station is fifty miles away. The question is: what price should your charge for your gas (regular)?
The fixed cost for your station is $500 per day. That covers your rent, employees and other business expenses.
The gas you sell costs $5.00 per gallon for delivery to this out of the way location.
On the accompanying sheet is the demand curve for gas at this location.
What price should you charge?
A) $6.00 per gallon
B) $6.50 per gallon
C) $7.00 per gallon
D) $7.50 per gallon
E) $8.00 per gallon

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Demand curve for Panamint Valley Gas (Acrobat (PDF) 22kB Aug15 12)

On the demand curve, graph average total costs, then shade in total costs, total revenue and profits for the price you chose as the best.

Panamint Valley Gas instructions (Microsoft Word 2007 (.docx) 13kB Jan21 18)
Follow on graphing question (Microsoft Word 2007 (.docx) 12kB Jan21 18)

Teams will be using a guess and check technique for finding the best price. If students ask if they can apply a MR= MC rule, compliment them on this insight but say that it isn't easy to do with the data available (and that is often the case in real life business.)

The cost and demand data are approximate, simplified for this example. The gas station is real and does have higher prices than stations nearer to the surrounding urban areas. Interviewed by the author, the gas station owner claimed that "only Americans complain about gas prices here, not the many foreign visitors on their way to Death Valley."

The graphing question can be completed by students individually to assess their understanding of the team results.

Transfer to other situations can be accomplished by questions regarding other monopoly situations. For example, how does a monopoly (say Microsoft) react to a change in variable costs (as when software was updated online rather than through physical disks). Or, how does a monopoly (say a utility) react to a change in fixed costs (as when property taxes were increased).