Running head: ECONOMICS FOR BUSINESSEconomics for BusinessName of the Student:Name of the University:Author’s Note:Course ID:
1ECONOMICS FOR BUSINESSThe natural monopolies are conducive to the industries, in which the largest supplierobtains cost advantages and it needs to be regulated for minimising risks. An industry incumbentdefines a natural monopoly, in which the biggest supplier could develop theoretically the lowestprices of production with the help of economies of scope or scale (Barata, 2017). Hence, thenatural monopoly conditions are at greater risk of developing actual economies and benefits ofthe society to regulate such situations. The regulating industries in order to reducemonopolisation along with maintaining competitive equality could be pursued with the help ofaverage pricing of cost, regulations related to return rate, price ceilings, subsidies and taxes.Thus, the current essay aims to describe the way and the reasons that the government might wantto regulate the price setting of a natural monopoly. Depiction of the way and the reasons that the government might want to regulate the pricesetting of a natural monopoly:The government might intend to regulate monopolies for ensuring the interests of theconsumers. For instance, the monopolies have market power in setting greater prices in contrastto competitive markets. The government could regulate monopolies with the help of standardrivalry, price capping and preventing monopoly power growth. There are several reasons that the government regulates the price setting of a naturalmonopoly. Firstly, the government aims to prevent additional increase in product or serviceprices. In the absence of government regulation, the monopolies could quote prices, which wouldexceed the competitive equilibrium (Bös, 2015).As a result, there would be inefficient allocationand fall in consumer welfare. Secondly, the government wants to regulate the price setting of anatural monopoly. For instance, if an organisation enjoys monopoly over the provision of a
2ECONOMICS FOR BUSINESSparticular product, it might have minimal incentive for offering effective quality service. Thegovernment regulation could assure the organisation to achieve minimum service standards(Davies, 2014). Thirdly, an organisation having monopoly selling power might be in a situation to exploitmonopsony purchasing power. For instance, the supermarkets might utilise dominant marketposition in squeezing the farmers’ profit levels. Fourthly, the government enforces regulation inorder to promote the overall competition in the economy (Hawley, 2015).This is because in fewindustries, competition could be assured and this would minimise the need for governmentregulation. Fifthly, some industries are adjudged as natural monopolies because of greatereconomies of scale and the effective number of firms is one. Hence, competition could beencouraged and it is necessary in regulating the organisation in protecting the abuse of monopolypower (Hiriart & Thomas, 2017). Several methods are available by which the government could regulate price setting in anatural monopoly. The first method is price capping on the part of the regulators through pricecapping regulators CPI-X. In case of newly privatised industries like electricity, water and gas,the organisation has developed regulatory agencies like OFGEM for the markets of electricityand gas, OFWAT for tap water and ORR for rail regulator office (Hirschfeld, 2015). Out of thesefunctions, they would be able to minimise the increase in prices. This could be accomplishedwith the help of a formula CPI-X. In this case, X is the amount by which the prices could beminimised in real terms. In case, inflation is 3% and X is 1%, the organisations could raise actualprices by 2% (3% -1%).
3ECONOMICS FOR BUSINESSIn case, the regulator views that an organisation could conduct efficiency savings and it ischarging additional to the customers, it could set a greater X level. In the beginning years of theregulation related to telecommunication, the X-level has been extremely high, as efficiencysavings help in larger price cuts.In case of water industry, the price cap system is CPI -/+K. K is the quantity ofinvestment, which the water organisation is needed to implement. Thus, if the waterorganisations are required to invest in effective water pipes, they would be able to raise theprices for funding their investments. There are various benefits of CPI-X regulation. Theregulator could adopt increase in prices based on the industrial state and potential savings relatedto efficiency. In case, an organisation minimises costs above X, they could raise their profitlevel. However, as argued by Jamal & Sunder (2014), incentives are inherent in minimisingcosts. As no competition is inherent, CPI-X is a method of raising competition and this limits theabuse of monopoly power. However, the CPI-X regulation is costly and difficult to analyse for ascertaining theoverall level of X. There is a risk associated with regulatory capture, in which the regulators aretoo soft on the organisation and this allows them in increasing prices to make adequate profitfrom investment. In addition, in case of inefficiency of a firm, penalty might be imposed on themby having greater X levels for keeping its efficiency saving. The regulators could investigate theservice quality provided on the part of the monopoly. For instance, the regulator of railinvestigates the record of safety related to rail organisations for assuring that they do not cutcorners. In the markets of gas and electricity, the regulators would ensure that the agedindividuals are treated with utmost concern. This includes not enabling an organisation to reducegas supplies in winter.
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