ECO511 - Economics for Business || Assignment


Added on  2020-02-23

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Running head: REGULATION IN NATURAL MONOPOLYRegulation in Natural MonopolyName of the StudentName of the UniversityAuthor note

1REGULATION IN NATURAL MONOPOLYIntroductionBased on the number of buyers and sellers, markets are classified in separatecategory. The market with a single seller is called a monopoly market. In the monopolymarket, the single seller grabs maximum profit and the entire surplus in the market byexploiting its market power. The monopoly market when compared to a competitive marketalways seems inefficient in terms of resulting in a deadweight loss. A special form of marketsimilar to a monopoly market is natural monopoly. It is a market that is best operated by asingle seller than two or more. In a natural monopoly market, the seller enjoys a cost advantage and able to producegoods at the falling part of average cost curve. Examples of natural monopoly market includeelectricity service, public water company and public utilities. Question of regulation comeswhen the natural monopolist starts taking operation decision like a pure monopolist. In such asituation, the monopolist chooses profit-maximizing level of output where a lower quantity issupplied at a high price. In such a situation, government has taken pricing decision by eitherfollowing an socially efficient pricing strategy. Efficiency comparison between monopoly and perfect competitionPerfect competition is a market scenario where there are numerous participants inmarket exchange operation. Market equilibrium occurs at a point where demand and supplycurve matches with each other. The presence of large number of buyers and sellers in themarket makes it impossible for a single buyer or seller to affect price or output. Therefore,efficient point is reached without any intervention (Hovenkamp, 2015). The market conditionwith competition among the sellers is described below.

2REGULATION IN NATURAL MONOPOLYFigure 1:Perfectlycompetitivemarket(Source: Ascreated bytheAuthor)Supply curve in the market coincides with marginal social cost and marginal benefitcurve is the same as market demand curve. Socially efficient point is reached where marginalsocial benefit (MSB) is matched with marginal social cost (MSC). In perfect competition, it issame as free market equilibrium where market demand equals market supply. Hence,equilibrium in competitive market is efficient as here MSC = MSB (Belleflamme & Peitz,2015). In the market, consumer enjoys considerable surplus that is the difference betweenconsumers willing price and actual market price. Consumer surplus is shown as the areaunder the demand curve lying above price. In contrast, the monopoly market is inefficient as here price is greater than socialmarginal cost. The monopoly determines its own price and is not a price taker as like acompetitive firm. Because of its market power, the monopolist always chooses profit-maximizing level of price and supply a lower quantity as compared to competitive market.The welfare loss because of a high price charged is shown by the triangle of deadweight loss.Figure 2 explains this.

3REGULATION IN NATURAL MONOPOLYFigure 2: Inefficiency of the monopoly market(Source: As created by the Author)The consumer surplus is now reduced to a small triangle. Some portion of the reducedsurplus is transferred to the monopolist as producer surplus. The transferred surplus is notconsidered as loss to the society (Schmidt, Spann & Zeithammer, 2014). The rest, which isreceived neither by the consumer nor by the producer, is an actual cost to the society. Natural MonopolyOne of the key features of a monopoly market is that entry of a new supplier iscompletely restricted in the market. Barriers can be of several forms. Ownership barrier, legalbarriers or natural barriers are some types of barriers ( Weimer & Vining, 2017). When entryis restricted with a natural barrier then it is called natural monopoly. The goods or servicesoffered in the natural monopoly market usually have an abnormally high fixed cost. As a

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