Understanding Marginal Cost Pricing
Added on 2020-02-24
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Running Head: Natural Monopoly RegulationWhy and how a Natural Monopoly is regulated by the GovernmentStudent NameInstitutional AffiliationCourse/NumberInstructor NameDue Date
Natural Monopoly Regulation2Why and how a Natural Monopoly is regulated by the GovernmentIntroductionA natural monopoly is a single supplier operating under a monopoly market structure. The production of goods or service for such a supplier is lower than in a competitive market. This monopoly has the ability to supply to the whole population since the goods are produced at the lowest possible cost (Riley, 2015). We shall see the reason as to why this supplier’s costs fall as production level is increased. The aim of this research is to find out why and how the government should regulate the natural monopolies. This question will be answered by choosing the best strategy to analyze this situation. On my choice, the best strategy will be to analyze the difference between a freely operated monopoly and a regulated natural monopoly. At the end of the analysis we shall determine whether it is important to regulate the operation of this market structure or to leave it to operate freely. By regulation, it means that it’s the government that sets the price level for the monopoly, whereas free operation means that price is influenced by the forces of demand and supply. The main aim of regulation is to maintain efficiency in the market by ensuring that the market is competitive (Hill, 2017). This paper shall determine the advantages of a competitive market and the disadvantages of low competition level. If the monopoly is found to carry out unfair pricing without the government’s regulation, we shall come to a conclusion that government regulation is crucial. Various theories of pricing for a natural monopoly will be introduced. The theories are aimed to promote efficiency and also ensure that the supplier is able to survive in this market without making losses. The theories to be covered are; price discrimination, marginal cost pricing, peak load pricing and average cost pricing. The expectation of this research is that natural monopolies practice unfair pricing when unregulated. This research will help the policy makers on understanding the various pricing policies that should be implemented on natural monopolies at different economic conditions.AnalysisUnlike in the competitive markets where the suppliers are many and price takers, the natural monopoly is an individual supplier who is a price maker. Supply and demand in competitive markets determines the price level. The natural monopoly’s market power is high and thus the ability to influence the price level. The influence could either by lowering the outputlevel. This explains why the competitive output level is very high compared to the reduced Student Name; Student ID
Natural Monopoly Regulation3quantity level for a natural monopoly. The higher output in competitive markets enable the price charged to be lower, and the limited supply for a natural monopoly is sold at high prices. The reason why the government is expected to regulate the natural monopoly is because it want to ensure that there is increased production of goods which wouldn’t be possible with the absent of regulation. It is not that a natural monopoly cannot be able to produce the competitive output, butit cannot make such a decision. However, the competitive quantity is could still be produced by the natural monopoly if the government forced them to do so. The government’s role is thereforeto enhance allocative efficiency in this market. The government has to take into account some factors before regulating a natural monopoly. One of the factors is that it should ensure that thereis no loss for the producer; the producer must break even in order to ensure sustained production.Fig: Unregulated natural monopoly pricingSource: Kelly & Jenny (2012)The ideal production level for unregulated monopoly is Q1 at MR = LRMC. This is where the corresponding price is P1. At this production level, the LRAC is below the demand curve. And since the demand curve determines the price level, the natural monopoly is making abnormal profit equal to area A (Greer, 2012). The monopoly would wish to continue enjoying the high profit and thus cannot raise its outcome beyond point Q1. Raising output would mean moving down along the demand curve; this would raise supply; in economics, an increased supply given a fixed demand level causes price to fall. The government cannot allow exploitationof consumers through high prices and thus the need to introduce regulations. Regulation may either be at the regulatory price setting level shown above or the allocative efficiency level. The Student Name; Student ID
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