Dynamic Natural Monopoly Regulation System †MyAssignmenthelp.com

Question: Discuss about the Dynamic Natural Monopoly Regulation System. Answer: Introduction Monopoly is a term frequently used by economists to define a state where the exists only one producer of a product which owns no close substitute or a state where there is only one company in an industry with the company possessing no substitute. Example of monopoly products includes electricity, cable television and water. These firms own certain characteristics: they have no close substitution, one seller with many buyers, there is a restriction of entry of new firms because of the substantial barriers, and they need no advertisement as they have got the right hand to control the market, they are the price makers. In some situations, enhance monopoly for national security issues, to attain economies of scale for international competition. A natural monopoly exists where there is a vast extension of output for which economies of scale are experienced, and therefore it is sensible that only one firm functions (DiLorenzo, 1996). Analyze this topic I selected some sources based on the content, validity, and relevance. By the conventional, mainstream economic theory, the fundamental economic harm originating from monopoly is because of marginal cost and dead weight loss (Posner, 1974). Deadweight loss is the loss resulting from the unrealized gains from trade. Another reason for regulation is for economic motivation: to enhance allocative efficiency. The regulation also creates new welfare because there exists more business in the market. Unregulated natural monopoly would try to seek to maximize their profits by outputting value of output where marginal cost is equal to the marginal revenue. This is the choice profit maximizing companies would prefer though it comes with a disadvantage of a huge deadweight loss (Demsetz, 1968). For the profit maximizing or unregulated policy option, the company will set their prices by aspiring to attain MR=MC Where; MR (marginal revenue) is the excess money obtained by selling an extra unit while MC (marginal cost) is the surplus cost of selling an additional unit. Simply if the money acquired is greater than or equal to the excess cost of availing the good or service to the consumer, then the exchange will be viable made (Joskow, 2007). Producing the profit-maximizing quantity of product causes a deadweight loss. The deadweight loss is equivalent to the region between the demand curve and the marginal cost curve for the underproduction amount. For the second pricing option in a natural monopoly: optimal quantity for society, the monopoly model produces the quantity where price is equivalent to marginal cost (and therefore marginal social cost equals to marginal social benefit). P=MC This option becomes the best deal for a consumer as the price is low and therefore no deadweight loss is experienced (Demsetz, 1968). When P (price)=MC (Marginal Cost), you realize that the price Popt is below the average cost for the same quantity. In case the average cost was below the price then, the firm would lose money. The only way for the company to outlive is to get subsidies from the government. These natural monopolies therefore necessarily need regulation to avoid the extremes (Joskow, 2007). But here comes a question how has the regulation been managed? Governments have tried regulating natural monopoly through the following ways. Price ceiling: this is where maximum potential price being charged is enforced. This a regulatory of setting that a particular commodity cannot be charged beyond certain predefined price (Posner, 1968). Another method is the average cost pricing: this is a strategy known for inflicting a price point for a particular product that matches the general cost incurred by the producer company. The approach decreases the pricing flexibility of a firm and ensures that monopoly cannot encapsulate the margins above and below that which is sensible (Berg, Tschirhart, 1988). Tax or subsidy is also a regulatory method. The government can charge higher taxes on big players or provide grants for the small players. The rate of return regulation is also a means which is quite similar to average cost pricing. The percentage net profit earned by a company must less than a government set interest top avail a competitive environment (Berg, Tschirhart,1988). As an alternative, the government can actually allow for the existence of natural monopolies and regulate their prices. The following are the three different types of price regulations which include: Differential Tariff Average cost pricing and Marginal cost pricing The monopolist primarily has to set the price at a break-even point which is the major requirement of this price regulation that is the feature where the price can cover its own costs. As these are the cost production of the economy minimum profit is covered by them, which is required in keeping the firm stable in the industry. In the following graph, this point has been shown where AC = AR. Price is represented at PR and the output is pointed by QR. This kind of system appears to be fair for all firms since the price is brought down for the customers while allowing the monopolist to still make a return on investment that is reasonable but there are some problems (Lim Yurukoglu, 2015). The economic costs can be defined as the one which includes the making of the profit that is at the level of the next alternative that is best which means the opportunity cost. However, it is not easy to define what exactly it means. For stating the percentage of the return on investment this is the common approach made. For instance, the monopolist might be given a chance of earning around 8 percent of return on investment. So if the assets are having the net value of 1 billion dollars, then it will have the chance of making 80 million dollars profit. The government will take the profits that are earned more than this (Hawley, 2015). A reasonable level of return is defined under the average cost of approach for which the monopolist may be attracted for changing the records of the account for maximizing the returns. For instance, for justifying the higher profits the value of assets might be overstated. A small amount of investment and innovation In general, better profits can be earned by a company if it is lowering its operating costs and improving its productivity. But if their profits are regulated, for instance, only an 8 percent return can be earned by it additionally it can have little incentive for developing the new products or the techniques for production which will cost them low. However, it is not beneficial for the customer in the long run (Hawley, 2015). The regulations of marginal cost pricing will be requiring the organization in producing the output level in such a way that supply equals to demand. It means that it is the output level at which the competitive market will produce at. Here in graph MC indicates the supply and AR indicate the demand. With this intervention, the major problem is that sub normal profits are able to be earned by the monopolist at this level of output. The firm has to be subsidized by the government for making sure of its stay in the production. In the following figure, the shaded area represents that the subsidy should be equal to the subnormal profits. The price that has to be paid by the consumers is shown by PR while the value earned by the monopolist is indicated by PS. This situation is similar to the marginal cost pricing except in the fact that for covering the subnormal profits the government will be allowing the firms to charge the customers. For doing this two charges are imposed on consumers by a firm that is a variable charge and a fixed charge. The economic loss is covered by the fixed charge that is the gap present between AR and AC at QR. The price that the consumers are willing to pay is the level at which the variable charge is set that is at the regulated output level QR the average revenue is demanded. Conclusion In conclusion, regulation of natural monopolies remains an essential role in the economy of nations. Regulations prevent the companies from abusing its market power and therefore do away with a deadweight loss. In case the natural monopoly is regulated to get the optimal quantity of output, the firm will suffer an economic loss thus a government subsidy should be given to the company to defecate financial loss. In this essay, the various methods that can be used by the government for regulating the prices of the natural monopoly have been discussed. It also gives the view over the different types of price regulations through which the intervention of government in price setting of a natural monopoly can be understood. For setting the natural monopolies the final solution has been found that it should be owned by the government itself. There are many advantages associated with it. The government will have the opportunity of choosing the maximization of its profits and also feed it back into the country the profits that have been earned are the benefits that are included in it. Also, it can even direct the monopoly in earning lower profits and in turn with the help of these low prices it can benefit the consumers. In addition to advantages, there are also limitations for this price setting. The government will be having the mixed record of demanding to run a business is the disadvantage of th is policy: some of the time it can be done well and some of the time it is not done to the level expected. This also indicates that the government has to use public funds rarely. Some of the problems that are involved in this policy are it might encounter by using the cost benefit analysis which is very much difficult for the government in putting a value on a certain type of benefits and costs. Another problem is that it is very difficult in identifying all kinds of potential benefits and costs. From the above discussion, it is understood that if governments do not regulate price settings for natural monopoly than the monopolist will be producing the output at the level of maximizing the profits. The level of output is below the output level of the market equilibrium always for the natural monopolist. It means that the production of goods will be less and the price of those goods will be higher in the competitive market. Since it is a monopoly and faces average revenue that is sloping downward; at an output level, the natural monopoly is produced below the market equilibrium that is perfectly competitive. This will reduce the excess consumer and producer and will be resulting in burden loss. References Posner, R. A. (1974). Theories of economic regulation. Demsetz H. (1968). Why regulate utilities?.The Journal of Law and Economics,11(1), 55-65. Berg S. V., Tschirhart, J. (1988).Natural monopoly regulation: principles and practice. New York: Cambridge University Press. Lim, C. S., Yurukoglu, A. (2015). Dynamic natural monopoly regulation: Time inconsistency, moral hazard, and political environments. Journal of Political Economy. Hawley, E. W. (2015). The New Deal and the problem of monopoly. Princeton University Press. Joskow, P. L. (2007). Regulation of natural monopoly.Handbook of law and economics,2, 1227-1348. Posner, R. A. (1968). Natural monopoly and its regulation.Stan. L. Rev.,21, 548. DiLorenzo, T. J. (1996). The myth of natural monopoly.The Review of Austrian Economics,9(2), 43-58.