6.4 The Effects of Government Intervention in Different Market Structures

A per-unit tax is a variable cost: it shifts MC (and AVC and ATC) upward, so the MR = MC quantity falls and price rises. A per-unit subsidy does the reverse. In competitive markets the tax burden splits by relative elasticity — the more inelastic side of the market bears the larger share.

A lump-sum tax or license fee is a fixed cost: it shifts ATC (and AFC) up but leaves MC untouched, so the profit-maximizing quantity and price do not change in the short run — only profit falls. Lump-sum subsidies likewise change profit without changing output.

For a natural monopoly, regulators face a tradeoff. The socially optimal price, P = MC, achieves allocative efficiency but usually forces losses because MC sits below the still-falling ATC, so the firm needs a subsidy to stay open. The fair-return price, P = ATC, lets the firm break even with normal profit (zero economic profit) while still cutting deadweight loss versus the unregulated monopoly price.