EC1004 - Natural Monopoly - Economic Assignment

[ECONOMICS
ASSIGNMENT]
[Type the abstract of the document here. The abstract is typically a short
summary of the contents of the document. Type the abstract of the document
here. The abstract is typically a short summary of the contents of the document.]
2017
xxxxx
xx

Introduction
A monopoly arising out of high fixed costs or start up costs is termed as a
natural monopoly. An industry where natural monopoly persists requires
unique raw material, specialized technology and other factors which are
necessary to operate. The government run public services such as water;
electricity and telecommunications are most common examples of Natural
monopoly. Generally natural monopolies tend to have high infrastructure
cost (Haworth).
The concept of Natural monopoly was characterized by John Stuart Mill, who
was of the opinion that prices would throw back the cost of production in lack
of natural monopoly.
In order to have good return on investment it has to acquire a large number
of customers. Therefore it is stated that industries which bear high start up
cost tend to have low average cost because with huge amount of customers,
the output tends to increase (Crugman, Version 7).
Let us explain the natural monopoly situation with the help of an example:
Demand P = 120-Q
Marginal Revenue MR = 120-2Q
Average cost AC = 15+ (400/Q)
Marginal Cost MC = 15
The average cost has a direct relationship with Marginal cost, because as the
AC increases MC tends to remain below the AC. In a natural monopoly AC
tends to decline with increasing quantity of output (J, 2012).
MR Q
MC
A
C
P

In the above example if the monopolist is allowed to set its own price and
output, then the condition implied would be MR=MC
120-2Q = 15 i.e. Q = 52.5
P = 120-52.5 = 67.5
With the increase in elasticity of demand the monopolistic prices can be
broken down. The competitors tend to increase the demand elasticity which
implies that if prices are increased part of your demand will go to other
competitors in the market (Kadariya, 2014).
There are various characteristics of Monopoly. Some of the characteristics
includes:
Unique vendor, As the market is prevailing with only a single vendor
in the market he takes the opportunity to control price and supply of
the goods. Due to its uniqueness there are multiple buyers in the
market so he has no control over the demand for the goods. No
alternate supply sources, (Kumar) The goods in the market doesn’t
have any alternate products available so there is monopoly of the
products. This bounds the customer to go for one product only as they
have no choice available to choose its products. Price: As the control
lies within the hands of monopolist, he can charge any price from its
customers for the same product which creates price discrimination.
Restriction to entry: The new entrants cannot enter the market as
the power lies in the hands of the monopolist (Patel, 2010). There are
many obstacles for the new competitors to beat the already existing
supplier. Firm and Industry: As there is only single firm operating in
the market, there is no difference between a firm and an industry.
Reasons of the rise of the monopolies are: The essential cause of monopoly
is the survival of barriers to entry. Barriers to entry have three forms of
origin: Ownership, the government gives the administrative control to single
organization to produce exclusive goods, efficiency of one single producer in
the cost of production rather than having multiple numbers of producers.
The various forms of Natural Monopoly are Regulated Natural Monopoly and
Unregulated Natural monopoly. The monopolist can enhance its profits by
generating the quantity of output, where MR = MC. This is known as
unregulated natural monopoly. The outcomes of unregulated natural
monopoly are: