Economics for Business: The Role of Government in Monopoly Regulation

This essay, focused on economics for business, analyzes the rationale and methods for government regulation of natural monopolies. It explores why governments intervene in industries where a single supplier is most efficient, such as utilities, to protect consumer interests and prevent price gouging. The essay discusses various regulatory approaches, including price capping (CPI-X), return rate regulations, and measures to promote competition and prevent abuse of monopoly power. It highlights the potential for monopolies to exploit market power and the government's role in ensuring fair pricing and service quality, considering the benefits and drawbacks of different regulatory strategies. The analysis extends to how these regulations impact industries like electricity and telecommunications, emphasizing the balance between economic efficiency and consumer welfare. The essay also examines how the government investigates the abuse of monopoly power and mergers that may lead to a monopoly.

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Economics for Business
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The natural monopolies are conducive to the industries, in which the largest supplier
obtains cost advantages and it needs to be regulated for minimising risks. An industry incumbent
defines a natural monopoly, in which the biggest supplier could develop theoretically the lowest
prices of production with the help of economies of scope or scale (Barata, 2017). Hence, the
natural monopoly conditions are at greater risk of developing actual economies and benefits of
the society to regulate such situations. The regulating industries in order to reduce
monopolisation along with maintaining competitive equality could be pursued with the help of
average 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 want
to regulate the price setting of a natural monopoly.
Depiction of the way and the reasons that the government might want to regulate the price
setting of a natural monopoly:
The government might intend to regulate monopolies for ensuring the interests of the
consumers. For instance, the monopolies have market power in setting greater prices in contrast
to competitive markets. The government could regulate monopolies with the help of standard
rivalry, price capping and preventing monopoly power growth.
There are several reasons that the government regulates the price setting of a natural
monopoly. Firstly, the government aims to prevent additional increase in product or service
prices. In the absence of government regulation, the monopolies could quote prices, which would
exceed the competitive equilibrium (Bös, 2015). As a result, there would be inefficient allocation
and fall in consumer welfare. Secondly, the government wants to regulate the price setting of a
natural monopoly. For instance, if an organisation enjoys monopoly over the provision of a

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particular product, it might have minimal incentive for offering effective quality service. The
government 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 exploit
monopsony purchasing power. For instance, the supermarkets might utilise dominant market
position in squeezing the farmers’ profit levels. Fourthly, the government enforces regulation in
order to promote the overall competition in the economy (Hawley, 2015). This is because in few
industries, competition could be assured and this would minimise the need for government
regulation. Fifthly, some industries are adjudged as natural monopolies because of greater
economies of scale and the effective number of firms is one. Hence, competition could be
encouraged and it is necessary in regulating the organisation in protecting the abuse of monopoly
power (Hiriart & Thomas, 2017).
Several methods are available by which the government could regulate price setting in a
natural monopoly. The first method is price capping on the part of the regulators through price
capping 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 electricity
and gas, OFWAT for tap water and ORR for rail regulator office (Hirschfeld, 2015). Out of these
functions, they would be able to minimise the increase in prices. This could be accomplished
with the help of a formula CPI-X. In this case, X is the amount by which the prices could be
minimised in real terms. In case, inflation is 3% and X is 1%, the organisations could raise actual
prices by 2% (3% -1%).

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In case, the regulator views that an organisation could conduct efficiency savings and it is
charging additional to the customers, it could set a greater X level. In the beginning years of the
regulation related to telecommunication, the X-level has been extremely high, as efficiency
savings help in larger price cuts.
In case of water industry, the price cap system is CPI -/+K. K is the quantity of
investment, which the water organisation is needed to implement. Thus, if the water
organisations are required to invest in effective water pipes, they would be able to raise the
prices for funding their investments. There are various benefits of CPI-X regulation. The
regulator could adopt increase in prices based on the industrial state and potential savings related
to efficiency. In case, an organisation minimises costs above X, they could raise their profit
level. However, as argued by Jamal & Sunder (2014), incentives are inherent in minimising
costs. As no competition is inherent, CPI-X is a method of raising competition and this limits the
abuse of monopoly power.
However, the CPI-X regulation is costly and difficult to analyse for ascertaining the
overall level of X. There is a risk associated with regulatory capture, in which the regulators are
too soft on the organisation and this allows them in increasing prices to make adequate profit
from investment. In addition, in case of inefficiency of a firm, penalty might be imposed on them
by having greater X levels for keeping its efficiency saving. The regulators could investigate the
service quality provided on the part of the monopoly. For instance, the regulator of rail
investigates the record of safety related to rail organisations for assuring that they do not cut
corners. In the markets of gas and electricity, the regulators would ensure that the aged
individuals are treated with utmost concern. This includes not enabling an organisation to reduce
gas supplies in winter.

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The government has a policy to examine mergers that would develop monopoly power.
In case, a new merger develops an organisation exceeding 25% of the market share, it is referred
automatically to the Competition Commission. Such commission could determine in allowing or
blocking the merger (Lim & Yurukoglu, 2015). In most cases, the government could determine a
monopoly, which is required to be broken up, as the organisation has become too powerful. For
instance, the US looked into segregating Microsoft; however, the action has been dropped. This
tends to be viewed as an extreme step and there is no assurance that the new organisations would
not collude.
In addition, there is a standard return rate in regulation of monopolies in the CPI-
X price capping. The return rate regulation views at the size of the organisation and evaluates
what would conduct a reasonable profit level from the base of capital (Lytton, 2014). In case,
there is excessive profit made on the part of the organisation in comparison to its relative size,
the regulator might enforce price cuts or take one off tax.
The government often enforces regulations for investigating the abuse of monopoly
power. In Australia, the fair trading office could examine the abuse of monopoly power. This
might take into account unfair trading practices. Some of these practices include collusion, in
which the firms agree to set greater prices (Mudambi, Navarra & Delios, 2013). Collusive
tendering takes place at the firms enter into contracts in fixing the bid at which they would place
tender for projects. The organisations would collect the same in tureen to obtain the contract
along with enabling a greater price for the contract.
Predatory pricing is another reason of enforcing government regulations, in which the
prices are kept to try to push the rival organisations out of the industry (Pan, 2014). Vertical
restraints are inherent in vertical restraints to restrict the retailers in stocking competitor

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products. The government is engaged in enforcing regulations for selective distribution. For
instance, in the Australian car industry, the organisations have entered into exclusive and
selective network of distribution for keeping greater prices. According to the report of the
Competition Commission, the Australian cars have been at least 10% greater in contrast to the
European cars.
The issue with monopolies is that a monopolistic organisation, left to its own
concurrence, would probably select in producing at a level of output, which is much lower and
provide the product at a greater price resulting from a purely competitive industry (Posner,
2014). A monopolist would produce, in which its price is higher compared to that of marginal
cost depicting an under-apportionment of resources towards the product. Through the restriction
of output and increasing its price, the monopolist is assured greater profits. However, this would
be accomplished at the societal cost of lower consumer welfare or surplus.
Figure 1: Price setting in a natural monopoly
(Source: Sokol, 2013)

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However, in few industries, due to the broad output range over which the economies of
scale are experienced, it creates the utmost sense for a single organisation to participate. These
markets are termed as natural monopolies and few examples include natural gas, cable television,
utilities and other industries having greater economies of scale (Stockwell et al., 2015).
The government regulators experience a dilemma to deal with natural monopolistic
industries like the electricity industry. For instance, an electricity organisation having a
monopoly in a specific market would base its output and price decision on the rule of profit
maximisation, which is prevalent amongst all the unregulated firms. Thus, the organisations
would manufacture at a level, in which the marginal revenue equals marginal cost. The issue for
a monopolist is that marginal revenue is lower than the price to be charged, which depicts that at
the level of profit maximisation of output, marginal cost would be lower than the price and
evidence related to allocating inefficiency.
This necessitates the requirement for government regulation. A government associated
with obtaining the right amount of electricity to the right number of individuals (allocating
efficiency) might select in a price ceiling for electricity at the extent, in which the marginal cost
of the organisation is equal to the price. This would be lower than the average overall cost of the
organisation (Tirole, 2014). However, this would lead to significant losses for the organisation
and this might lead to shut down of the same. Hence, the government needs to set a price ceiling,
in which the price is identical to the average overall cost of the organisation implying that the
firm would accomplish break-even by earning normal gain.
From the above discussion, it has been found that the natural monopoly conditions are at
greater risk of developing actual economies and benefits of the society to regulate such

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situations. The regulating industries in order to reduce monopolisation along with maintaining
competitive equality could be pursued with the help of average pricing of cost, regulations
related to return rate, price ceilings, subsidies and taxes. Thus, the current essay has described
the way and the reasons that the government might want to regulate the price setting of a natural
monopoly.
In addition, it has been observed that an organisation having monopoly selling power
might be in a situation to exploit monopsony purchasing power. For instance, the supermarkets
might utilise dominant market position in squeezing the farmers’ profit levels. Along with this,
the government enforces regulation in order to promote the overall competition in the economy.
This is because in few industries, competition could be assured and this would minimise the need
for government regulation. Fifthly, some industries are adjudged as natural monopolies because
of greater economies of scale and the effective number of firms is one. Hence, competition could
be encouraged and it is necessary in regulating the organisation in protecting the abuse of
monopoly power.
The government regulators experience a dilemma to deal with natural monopolistic
industries like the electricity industry. For instance, an electricity organisation having a
monopoly in a specific market would base its output and price decision on the rule of profit
maximisation, which is prevalent amongst all the unregulated firms. Thus, the organisations
would manufacture at a level, in which the marginal revenue equals marginal cost. The issue for
a monopolist is that marginal revenue is lower than the price to be charged, which depicts that at
the level of profit maximisation of output, marginal cost would be lower than the price and
evidence related to allocating inefficiency.

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References:
Barata, J. (2017). Spain: From Monopoly to Liberalisation. Two Decades of
Telecommunications Regulation. Australian Journal of Telecommunications and the
Digital Economy, 4(4), 80-88.
Bös, D. (2015). Pricing and price regulation: an economic theory for public enterprises and
public utilities (Vol. 34). Elsevier.
Davies, A. (2014). Regulation and Productivity. Mercatus Center at George Mason University.
Hawley, E. W. (2015). The New Deal and the problem of monopoly. Princeton University Press.
Hiriart, Y., & Thomas, L. (2017). The optimal regulation of a risky monopoly. International
Journal of Industrial Organization, 51, 111-136.
Hirschfeld, K. (2015). Introduction. In Gangster States (pp. 1-22). Palgrave Macmillan UK.
Jamal, K., & Sunder, S. (2014). Monopoly versus competition in setting accounting
standards. Abacus, 50(4), 369-385.
Lim, C. S., & Yurukoglu, A. (2015). Dynamic natural monopoly regulation: Time inconsistency,
moral hazard, and political environments. Journal of Political Economy.
Lytton, T. D. (2014). Competitive third-party regulation: How private certification can overcome
constraints that frustrate government regulation. Theoretical Inquiries in Law, 15(2), 539-
572.

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Mudambi, R., Navarra, P., & Delios, A. (2013). Government regulation, corruption, and
FDI. Asia Pacific Journal of Management, 30(2), 487-511.
Pan, S. W. (2014). Countermeasures for Regulating Income Distribution in Monopoly Industries
of China. International Journal of Management Science and Engineering Research, 1,
16-20.
Posner, R. A. (2014). Economic analysis of law. Wolters Kluwer Law & Business.
Sokol, D. D. (2013). Merger Control Under China's Anti-Monopoly Law.
Stockwell, T., Zhao, J., Marzell, M., Gruenewald, P. J., Macdonald, S., Ponicki, W. R., &
Martin, G. (2015). Relationships between minimum alcohol pricing and crime during the
partial privatization of a Canadian government alcohol monopoly. Journal of studies on
alcohol and drugs, 76(4), 628-634.
Tirole, J. (2014). Market power and regulation. Scientific Background on the Sveriges Riksbank
Prize in Economic Sciences in Memory of Alfred Nobel.