Monopoly Market Structure | Price Setting Regulation

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Running Head: Natural Monopoly Market StructureThe Regulation of Price Setting in Natural a MonopolyStudent NameInstitutional AffiliationCourse/NumberInstructor NameDue Date
Natural Monopoly Market Structure2The Regulation of Price Setting in Natural a MonopolyIntroductionA monopoly refers to a market structure where there is only one provider of a service or aproduct without any close substitutes or competitors.Riley(2015) notes that in such a setting,the market must not be necessarily nationwide but the term “monopoly” can be used in referenceto a territorial market. Having noted the foregoing, attention is given to the term “naturalmonopoly.” It is noted that the term natural monopoly is not in any manner used in actualreference to the actual number of providers of the same service or product in a particular marketsetting. Instead, refers to the interconnection between demand for a service or a product and thesupply technology employed to avail the service or a product to the consumers. A naturalmonopoly therefore refers to a situation where either one of the firms in a particular industry isable to meet the demand of a common product or service at the lowest cost where otherwise itwould be costly for two or more firms to meet (Riley, 2015).A natural monopoly presents a dilemma to public policy. This is in the sense that whereasthey imply production efficiency, at the same time, the lack of competition presents themonopoly firm the opportunity to exploit consumers for profit maximization. In a naturalmonopoly market where there are two or more firms, two outcomes are likely. In the firstinstance, the firms are likely to merge or they will fail and leave one dominating the market. Inthis case, competition in such a market will be short lived. In the second instance, the two formsmay continue to operate parallel to each other, in which case the high cost of production willconsume more resources which will be an inefficient operative standard (Minamihashi, 2012).On this front, one can argue that to ensure efficiency, competition in a natural monopoly is not aviable regulatory mechanism. Rather, the adoption of “direct controls” as a viable regulatorymechanism should be considered.This paper examines in great detail the economics of scale for a natural monopoly andbriefly presents the advantages and disadvantages of a natural monopoly market structure. Theneed for the regulation of prices and means of regulation are then discussed before drawing ageneral conclusion. The information contained in this research shall be beneficial to theconsumers, the public and students, all of whom need to appreciate the importance of natural
Natural Monopoly Market Structure3monopolies and the economic considerations to be noted when dealing with a similar marketstructure.AnalysisA monopoly market is characterized by entry barriers which present obstacles to otherfirms intending to break ground into the industry or market dominated by the monopoly firm.This allows the dominant firm to continue operation as a sole provider of the product or servicein the industry and in turn make supernormal profits as shown infigure 1below. These barrierscome in the form of patents, licenses, high start-up capitals, economies of scope, productdifferentiation, among others. Of particular interest in this research is the barrier of economies ofscale where unit cost reduction is dependent on output size. This barrier is discussed in detailbelow.Economies of Scale for a Natural MonopolyAs noted above, monopolies present a challenge of having the latitude to produceproducts at lower output levels such that the end product is priced higher than it would in acompetitive market setting. In essence, the restricted output levels maximize profits withouttaking into account consumer welfare (Welker, 2013). However, due to economies of scale, it ismost economically sensible when only a single firm operates in a certain market such as is thecase in the natural gas industry, cable TV, water and sewerage, electricity, among others. In anatural monopoly, the monopoly holder sets the product price and output levels based on theprofit maximization rule. This rule holds that unregulated firms produce at the level wheremarginal revenue equals marginal costs. The challenge with this rule is that for such firms,marginal cost and average cost is lower than the price charged and therefore, if the profitmaximization rule is applied, this would result in allocative inefficiency whereby the productwill not be affordable to some consumers (Opentextbc.ca. 2016).The diagrams below illustratethe economies of scale in a natural monopoly:
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