Regulating Monopoly Power in Markets

This assignment delves into the complexities of regulating monopoly power within markets. It examines the benefits and drawbacks associated with a monopolist's ability to set prices above competitive levels. Two primary pricing regulations are analyzed: socially efficient marginal pricing and the rule of average pricing. Additionally, the limitations of cost-plus pricing as a regulatory mechanism are discussed, highlighting price cap regulation as an alternative approach.

Running head: BUSINESS ECONOMICS
Business Economics
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1BUSINESS ECONOMICS
In economic sense, the market depicts the relation of exchange between the purchasers
and sellers. The particular market category is reliant on the various market aspects like the
presence of number of buyers and sellers in the market, the kind of products sold in the market
and the overall market size (Akram, 2014). The most prevalent market categorisation depends on
the sellers and purchasers in the market. The effective apportionment of resources is reliant on
the particular market structure. Hence, there would be efficiency in apportionment with the fall
in market power. In this context, the market power is greatest in case of a seller operating in the
monopoly market, which could be featured with the help of many purchasers and a sole seller.
Thus, a monopoly market in general sense is inefficient in contrast to competitive market.
An associated form of pure monopoly is identified as the natural monopoly. The primary
difference between these two forms is that in presence of a pure monopolist, competition is
highly preferred to a sole seller. However, in the market of natural monopoly, the presence of a
single seller entails greater efficacy (Anderson et al., 2014). The main reason behind this is that
the natural monopolist is involved in operating at average cost curve point for enjoying the
overall scale benefits. In the market of natural monopoly, the realisation for government
regulation is needed for assuring an effective pricing.
Explaining why and how the government might want to regulate the price setting of a
natural monopoly:
In the standard market of monopoly, the equilibrium condition of quantity and price is
obtained from the condition of profit maximisation. The monopolist controls the price in the
monopoly market. The point in which the sales from selling marginal quantity align with the
production cost of marginal quantity is taken into account as the profit maximising point. The

2BUSINESS ECONOMICS
monopoly market price is above the marginal cost generating income for the monopolist. The
following figure depicts the monopoly market condition, in which the shaded region depicts the
monopolist’s profit:
Figure 1: Condition of the monopoly market
(Source: Biondi & Zambon, 2013)
The competitive market mechanism is not identical. The condition related to free market
supply demand ascertains output and price in the competitive market. Both the marginal benefit
curve and demand curve are identical with the market supply curve. Hence, aligning supply and
demand reveals parity between marginal social cost and marginal social benefit; thus, denoting
its social efficiency (Bottazzi, Secchi & Tamagni, 2014). The situation of the market in
competition and monopoly has been presented in the below-stated figure:

3BUSINESS ECONOMICS
Figure 2: Comparison between monopoly market and competitive market
(Source: Cucculelli, & Bettinelli, 2015)
The marginal social cost curve or supply curve is the monopolist’s marginal cost curve.
Pm and Qm represent price and quantity in the monopoly market, while in case of competitive
market, they are Pc and Qc. From the above diagram, it is evident that Pm is more than Pc and
similar is the case in quantity as well. The societal loss in relation to monopolist operations and
resulting low output along with greater price is depicted as the societal deadweight loss.
From the previous discussion, it is inherent that the position of a sole seller is not
desirable from the social perspective in the monopoly market. The formation of barriers to entry
helps in retaining the sole supplier status. In the natural monopoly market, the natural barrier
prevents the entry of new sellers into the same (Dostál, 2013). The natural barriers denote the
conditions, in which the other organisations do not reveal interest in entering the market due to
greater fixed cost. The government often develops regulatory entry barriers for retaining the
market efficacy with a sole supplier.

4BUSINESS ECONOMICS
The average variable cost and average fixed cost comprise of average total cost. In case
of higher fixed cost, it declines at a rapid rate with rise in level of output due to which fixed cost
does not rise with rise in output. Due to this, there would be decline in average total cost with
rise in the output range (Gillespie, 2013). The situation is similar in case of a natural monopoly
market. There is existence of natural barrier in relation to greater fixed cost. The average overall
fixed cost would fall rapidly with a greater fixed cost. As a result, the monopolist experiences
benefits in relation to economies of scale. If this scale is present, it is possible for the monopolist
to operate at any place in the declining portion of average cost curve.
The sole seller in the natural monopoly market has scope for increasing profit like a pure
monopolist. There would be higher profit for the natural monopolist due to efficiency of scale.
The identical price output mix is charged on the part of the monopolist like the general monopoly
market (Granger, 2014). As a result, the requirement for regulatory price arises in the market of
natural monopoly. Socially efficient price is the price collected from the condition of pricing
identical to that in a competitive market. However, adopting competitive pricing might impose
extra loss burden. Therefore, the regulators select the most feasible alternative option.
The natural monopoly market could avail three kinds of options related to pricing. Firstly,
the market of natural monopoly in the absence of any regulation is taken into account. In
addition, the monopolist could select the profit maximising level of output by charging greater
price in the absence of administrative control over the market prices charged. The condition of an
unregulated monopoly market is depicted in the form of a figure as follows:

5BUSINESS ECONOMICS
Figure 3: Unregulated natural monopoly
(Source: Hill, Cronk & Wickramasekera, 2013)
In the absence of regulatory framework, the natural monopolist selects the point of
equilibrium, in which the profit from additional sales expressed with the help of marginal
revenue coincides with the additional cost unit expressed with the help of marginal cost curve.
The combination of price output is depicted with the help of point E in the above diagram. The
gain of the unregulated natural monopolist is the place depicting the variation between overall
revenue and overall cost.
In an unregulated condition, the natural monopolist might deprive the purchasers entirely
reliant on the monopoly supplier by serving them at a greater price for a low output. Thus, the
regulators need to ensure that an optimal quantity of a food is sold at a reasonable market price.
Firstly, the best societal choice is to select the price with the help of marginal pricing rule. In
case of a competitive market, the price is ascertained with the help of marginal cost level (Link
& Welsh, 2013). Since marginal cost curve and social benefit curve are identical, the price

6BUSINESS ECONOMICS
matches with the receipt of social benefit; thus, making it socially optimal. In competitive
market, the price obtained is only adequate in recovering overall production cost along with
generation of normal profit. This is not the condition in case of natural monopoly market.
A distinguishing characteristic of the market of natural monopoly is the declining average
cost. When the average cost range starts to decline, the average cost is greater in contrast to the
marginal cost. Hence, if price is ascertained through the rule of marginal cost pricing, the
monopolist might find it extremely difficult in recovering the production cost and earned overall
revenue. This could in serious losses for the monopolist. Despite the efficiency of marginal cost
pricing, it might result in loss for the monopolist.
In case, the regulators compel the monopolist in implementing the pricing rule, the loss
needs to be accounted, while some alternatives need to be offered as well for recovering the
losses. The monopolist might select a strategy of price discrimination, which is considered as
two-part pricing as well. In this strategy, two distinct prices are charged in two different market
parts. The buyers with lower elasticity are offered products at greater prices, while the consumers
with greater elasticity are offered products at lower prices. Price discrimination increases the
revenue of the monopolist, since the same is able to capture greater consumers and producer
surplus (Memili et al., 2015). Another alternative option available for the monopolist is to charge
a fixed fee, which the buyers need to pay once. After payment of the same, marginal cost
becomes identical with the price.
However, if the monopolist is left to recover the loss solely, it could lead to inefficiency.
Thus, for charging the pricing of marginal cost, effective governmental support is required for
absorbing losses. The regulator or government needs to pay directly to the monopolist a loss

7BUSINESS ECONOMICS
amount, which could be termed as subsidy. This subsidy is generated from the governmental
revenue. Hence, for making payment of subsidy, it is necessary for the government to raise the
rate of tax, which could result in distortion in the society. In the below-depicted figure, effective
quantity and price are represented as PE and QE.
Figure 4: Various pricing strategies under natural monopoly
(Source: Naudé, 2013)
Sometimes, it might occur that the distortion developed from raised tax is higher
compared to the deadweight loss resulted in an unregulated market of monopoly. Under such
scenario, there is greater inefficiency in regulation. The other feasible option is to follow the rule
of average pricing, in which equation is made for ascertainment of price with the average
production cost. As natural monopolist shifts production to the left of average cost curve, the

8BUSINESS ECONOMICS
same is identical with marginal cost. At the time the set price matches the average cost, the
revenue gained from overall sales aligns with the overall cost of production. In this situation, the
monopolist could make normal gain like that of a competitive organisation. Hence, this could be
taken into account as an effective point of operation. The corresponding quantity and price are
denoted as Qr and Pr respectively. As identified from the diagram, the area of overall cost and
overall revenue are identical and the monopolist could make only normal profit.
The regulation of price with the help of average cost depicts to have efficiency over
marginal cost pricing, since no excess burden is placed on government budget obtained from IAS
due to operation at a lower point compared to the average cost (Stiglitz, 2017). The regulation
depending on the monopolist cost is considered as the cost plus regulation. The general method,
in this case, is to maintain a record on the market cost. The regulators often encounter
complexities to implement cost plus generation, as it never discloses actual cost of production.
The monopolist tends to possess a general tendency in revealing an overestimated cost figure.
Moreover, at the time pricing relies on projected cost, the monopolist is not worried about
greater cost (Wilson & Post, 2013).
The additional cost burden could be transferred to the customers easily in relation to a
greater price. In the current era, the application pertaining to cost plus regulation has been
minimised. This is because the regulators have started to lay stress on the mechanism of
alternative price setting as price cap regulation. This regulation is a mechanism, in which a
ceiling or cap is based on the market price, as the price is formed for a specified timeframe
(Summers, 2014). For raising profit share within caped price, it is necessary for the monopolist
to minimise cost. The monopolist employs the advanced technologies related to cost savings for
raising profits, which increases the efficacy of production. Moreover, additional investment is

9BUSINESS ECONOMICS
made for installation of advanced technologies and innovation. In this situation, the efficiency of
price cap regulation arises. In case of cost plus generation, price is ascertained depending on the
projected cost and hence, only cost information is needed. For the regulation of price cap,
forming an effective price is a complex task. The ceiling price needs to be neither too high nor
too low. The price needs to be realistic so that no parties could experience loss from transactions
and efficient exchange is made in the market (Ward & Begg, 2016).
The essay highlights various pricing strategies that could be undertaken in a natural
market. Some evident features of natural monopoly market differ from the market of pure
monopoly. The natural market of monopoly is depicted for displaying the production scale in the
operations of the market. However, in case of deregulation, the natural monopolist could avail
benefits of the monopoly power along with charging a greater price. The regulation is necessary
to assure the market efficiency. Two pricing strategies are available for the regulators. The one is
socially efficient or marginal pricing and the other is the rule of average pricing. The regulation
under the mechanism of cost plus pricing relies on the monopolist and it often fails in ensuring
effective pricing. An alternative regulation method is the price regulation by forming a ceiling on
it adjudged as price cap regulation.

10BUSINESS ECONOMICS
References:
Akram, T. (2014). The economics of Japan’s stagnation. Business Economics, 49(3), 156-175.
Anderson, D. R., Sweeney, D. J., Williams, T. A., Camm, J. D., & Cochran, J. J.
(2014). Statistics for business & economics, revised. Cengage Learning.
Biondi, Y., & Zambon, S. (Eds.). (2013). Accounting and business economics: Insights from
national traditions. Routledge.
Bottazzi, G., Secchi, A., & Tamagni, F. (2014). Financial constraints and firm dynamics. Small
Business Economics, 42(1), 99-116.
Cucculelli, M., & Bettinelli, C. (2015). Business models, intangibles and firm performance:
evidence on corporate entrepreneurship from Italian manufacturing SMEs. Small
Business Economics, 45(2), 329-350.
Dostál, P. (2013). The use of soft computing for optimization in business, economics, and
finance. Meta-heuristics optimization algorithms in engineering, business, economics,
and finance, 41-86.
Gillespie, A. (2013). Business economics. Oxford University Press.
Granger, C. W. J. (2014). Forecasting in business and economics. Academic Press.
Hill, C. W., Cronk, T., & Wickramasekera, R. (2013). Global business today. McGraw-Hill
Education (Australia).

11BUSINESS ECONOMICS
Link, A. N., & Welsh, D. H. (2013). From laboratory to market: On the propensity of young
inventors to form a new business. Small Business Economics, 40(1), 1-7.
Memili, E., Fang, H., Chrisman, J. J., & De Massis, A. (2015). The impact of small-and medium-
sized family firms on economic growth. Small Business Economics, 45(4), 771-785.
Naudé, W. (2013). Entrepreneurship and economic development: Theory, evidence and
policy. Browser Download This Paper.
Stiglitz, J. E. (2017). The overselling of globalization. Business Economics, 1-9.
Summers, L. H. (2014). US economic prospects: Secular stagnation, hysteresis, and the zero
lower bound. Business Economics, 49(2), 65-73.
Ward, D., & Begg, D. (2016). Economics for business. McGraw-Hill.
Wilson, F., & Post, J. E. (2013). Business models for people, planet (& profits): exploring the
phenomena of social business, a market-based approach to social value creation. Small
Business Economics, 40(3), 715-737.