Economics for Business: Why and How Government Regulates Monopolies

This report delves into the economics of government regulation of monopolies, examining both the rationale behind such interventions and the specific methods employed. It begins by outlining the reasons for government involvement, including preventing excessive pricing, ensuring service quality, addressing monopsony power, fostering competition, and managing natural monopolies. The report then details various regulatory approaches, such as price capping using the RPI-X formula, quality of service regulations, merger policies, breaking up monopolies, and rate of return regulations. It highlights the benefits and limitations of each method, particularly in the context of natural monopolies like electricity companies, where price and output decisions are heavily influenced by profit maximization. The analysis underscores the importance of government regulation in protecting consumer interests and promoting economic efficiency, concluding that without intervention, monopolies can set prices to maximize profits, potentially at the expense of consumer welfare and service quality. The report draws upon a variety of academic sources to support its arguments.

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Introduction
This study deals with explaining how and when government may want to regulate the
price setting of a natural monopoly (Ward & Begg, 2016). The current segment explains the
reasons to why Government regulates monopolies. Some of the reasons are prevention of excess
prices, value of service, Monopsony power, encourage competition and normal monopolies. To
that, the next segment explains how the government regulates monopolies. Price capping by
controller, guideline of value of service, merger policy, breaking up a monopoly, rate of return
regulation and assessment of abuse of monopoly power are some of the conduct on how
Government control monopolies (Greco, Matarazzo & Słowiński, 2016). It is noted that
Government regulators faces difficulty in dealing with natural monopolies in industries such as
electricity business. It is because an electricity company with a monopoly in a specific market
will definitely base its price as well as output decisions on the profit maximization regulation. To
this, there is requirement for government regulation as the government is intended with getting
the right amount of electricity to the right number of group that means allocating efficiently. This
means the Government may select to set a price ceiling for electricity at the level where the price
equals the marginal cost of the firm (Vogel, 2014).
A monopoly can be termed as business or organization that maintains exclusivity if the
supply of a specific product or service as evolves naturally or designed specifically that depends
upon the nature of a market or industry (Tietenberg & Lewis, 2016). In addition, Monopolies are
governed under laws both on a national levels in countries and international levels through
involvement of institutions like World Trade Organization. The concept of monopoly considered
as a danger to free markets where there are particular situations takes place when natural
monopolies are either practically helpful or cost efficient or practically inevitable. In most of the

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extreme situation, it becomes the most feasible alternative for governments to break up
monopolies by using lawful procedure in the most appropriate way (Greco, Matarazzo &
Słowiński, 2016).
Analysis
Reason to why Government regulates monopolies
Preventing excess prices- It is important to understand the reason behind why Government
regulates natural monopoly is to stop excess prices (Shefrin, 2015). If there is no involvement of
Government, then monopolies could set prices above the competitive equilibrium as and when
required. This circumstance would lead to allocating incompetence as well as decline in the
customer wellbeing as a whole.
Quality of service- Regulation by Government are important, otherwise firms has a monopoly
over the stipulation of specific service where they may have little inducement to present to get
access good quality service. When there is government intervention to natural monopoly, the
firm is bound to meet minimum standards of services (Posner, 2014).
Monopsony power- It is noted that a firm that has monopoly selling power tends to remain in a
location to use Monopsony buying power (McCabe & Snyder, 2015). For instance, supermarkets
usually use their chief market position to condense the profit margins of farmers.
Encourage competition- In some of the industries, it is feasible to support competition and that
leads to condition where there will be less need for government instruction (Lim & Yurukoglu,
2015).

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Natural monopolies- It is found that some of the business is natural monopolies because of high
economies of scale. In addition, it is not likely to support competition in this type of business and
it becomes stipulation to manage the business to evade the abuse of monopoly power (Hawley,
2015).
Explain on how the Government regulates monopolies
“Price capping by regulators RPI-X” (Retail-Prices Index)- For most of the lately privatized
industries like water, gas and electricity, the government had shaped dictatorial bodies (Greco,
Matarazzo & Słowiński, 2016). OFGEM is for gas and electricity markets, OFWAT for tap
water and ORR is for Office of rail regulator.
Irrespective of their rationale, the Government is able to limit the increased price. They
can do it with a formula (RPI-X), where X is the amount by which they have to cut prices by in
real terms. For illustration, if rate of inflation is 3% and X equals 1%, then firm can improve
actual prices by (3-1)= 2% (Granger, 2014).
In addition, if a regulator feels that a business can make competence savings as well as
charging too much from the customers, them they can set high level of X. For illustration, in the
early years of telecom set of laws, the level was quite high as competence savings enables big
price cuts (Grammenos, 2013).
“RPI+/-K-for water industry”- In case of water, the price cap system is RPI -/+K
Here, K is the amount of investment where the water firms need to execute. In addition, if water
companies need to spend in better water pipes, then they will be able to boost prices to backing
the speculation (Fourcade & Khurana, 2013).

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Benefits of RPI-X Regulation
One of the benefits to RPI-X Regulation is that the supervisory body can set the price increase
that mainly depends upon the state of the business as well as possible efficiency savings (Cowen
& Tabarrok, 2015).
Other benefits of RPI-X Regulation is that if a firm cut costs by more than X, they can easily
increase the profits. In addition, the firm can even argue that there is an incentive to cut costs
(Greco, Matarazzo & Słowiński, 2016).
Other benefits of RPI-X Regulation are surrogate competition. Without competition, RPI-X is
one of the ways to increase competition as well as preventing the abuse of monopoly power
(Comanor et al., 2014).
Limitations of RPI-X Regulation
One of the limitations of RPI-Regulation is expensive and complicated in deciding the
component that what the level of X should be
There is a risk of authoritarian capture where the supervisor becomes too soft on the business as
well as allows them for increasing prices and making supernormal profits (Bös, 2015).
In addition, business may argue with the regulators as they are stringent and do not permit the
firms to make enough profits for investment (Ward & Begg, 2016)
For instance, if firms become very much efficient, the firms may be penalized by having higher
levels of X where they cannot keep their efficiency savings (Greco, Matarazzo & Słowiński,
2016).

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Regulation of quality of service- It had been found out those regulators examines the value of
services as given by the monopoly (Ward & Begg, 2016). For instance, the rail manager mainly
inspects the safety evidence of rail firms so that they do not cut corners. Another example is gas
and electricity markets where the supervisor make sure that old people are treated with care such
as not allow a monopoly to cut off gas provisions in winter (Anderson, 2013).
Merger policy- It is noted that the Government has the strategy where they examine mergers
that could generate monopoly power. For instance, if a new merger generates a business with
more than 25% of total market share, then it repeatedly referred to the Competition Commission.
After that, it is the responsibility of Competition Commission to choose whether to permit or
obstruct the merger (Greco, Matarazzo & Słowiński, 2016).
Breaking up a monopoly- It may happen in most of the cases where the Government can
choose upon monopoly needs that are to be wrecked up when it is seen that firm has become too
powerful. This type of situation hardly takes place (Ward & Begg, 2016).
Yardstick or rate of return regulation- Rate of return regulation is an unusual way of
changeable monopolies to the RPI-X price capping. To this, this guideline looks at the size of the
firm as well as evaluates on the fact on what is needed for getting access to rational level of
income from the resources base. For instance, if a business is making too much profit as contrast
to their relation size, then the controller may implement price cuts for solving the problem (Ward
& Begg, 2016).
Return on return regulation also has certain limitations as it encourages cost padding
(Comanor et al., 2014). For instance, the regulation is implemented when firms permit costs to
increase so that profit levels are not extreme. In addition, this type of regulation provides little

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inducement to be competent as well as increase profits. Therefore, the rate of return directive
may fail for evaluating how much profits can be rational. In that case, it the profits are set too
high, and then the business can abuse its monopoly power.
Assessment of abuse of monopoly power- It is noted that the office of fair training aims at
examining the abuse of monopoly power. In addition, there are several unfair trading practices
that take place and some of these are as follows:
Collusion takes place when firms agree to set higher prices (Comanor et al., 2014)
Collusive tendering takes place when business penetrate into conformity for fitting the bid at
which they will tender the profits. In addition, the business will take it for receiving the
agreement as well as enabling a much high price for the agreement (Greco, Matarazzo &
Słowiński, 2016).
Predatory pricing takes place when the firm set low prices so that they force rival firms to go out
of business (Ward & Begg, 2016)
Selective distribution
Vertical restraints takes place when the firms prevents retailers stock rival products (Comanor et
al., 2014)
Conclusion
From the above analysis, it is concluded that there is need for government regulation for
regulating natural monopolies otherwise firms will set prices with a view to gain maximum
profits and will not be considerate towards the quality of products and services assistance. The
Government may wish to direct natural monopoly in order to protect the interests of the

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consumers. For illustration, monopolies have the market authority where they can set prices high
than the aggressive markets. Ways adopted by Government to control natural monopolies can be
price capping, avoiding the expansion of monopoly power and yardstick competition.

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