Natural Monopoly Regulated Government †Free Samples to Students

Question: Discuss about the Natural Monopoly Regulated Government. Answer: Introduction A natural monopoly is a single supplier operating under a monopoly market structure management. 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 suppliers 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 its the government that sets the price level for the monopoly, w hereas 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 governments 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. Unlike in the competitive markets where the suppliers are many and price takers, the natural monopoly management is an individual supplier who is a price maker. Supply and demand in competitive markets determines the price level. The natural monopolys market power is high and thus the ability to influence the price level. The influence could either by lowering the output level. This explains why the competitive output level is very high compared to the reduced quantity 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 wouldnt be possible with the absent of regulation. It is not that a natural monopoly cannot be able to produce the competitive output, but it cannot make such a decision. However, the competi tive quantity is could still be produced by the natural monopoly if the government forced them to do so. The governments role is therefore to 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 there is no loss for the producer; the producer must break even in order to ensure sustained production. 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 exploitation of 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 advantage of competitive markets is low prices and high output level. This is illustrated in the graph below. The competitive level is at the Qoptimal level where the marginal cost cuts the demand curve at the ideal outcome point shown in the above graph. The unregulated monopoly cannot produced this quantity level and cannot produce at the ideal outcome level. However, the government may regulate the natural monopolies and force them to produce at the regulated price and produce quantity Qoptimal (Hanks, 2017). The government cannot regulate the natural monopoly and leave it to operate at that point as it can be observed that a loss is incurred if the ideal outcome is produced; this is because at this point, the average total cost is higher. The government is thus required to subsidize the natural monopoly for the losses to be incurred if quantity Qoptimal is produced at a higher cost. The compromise outcome is lower than Qoptimal but at a higher price. According to Bragg (2017) the basis for setting the price when considering the marginal cost is dependent on the market prices. The margina l costing pricing is criticized for not taking into account the fixed costs of production. Thus the price charged has to be set above the MC in order to ensure that the fixed costs of production are covered (Sanandres.esc.edu.ar, 2017). After the fixed cost are covered the extra surplus is the profit for the monopoly firm. Calculation of marginal cost is easy as it only involves the variable costs facing the natural monopoly. The price at D = MC is the efficient level as there is no deadweight loss. However since we have noted that the monopoly makes loss at this point and requires government subsidies, the government opts to use the Average cost to regulate a natural monopoly (Stein, 2017); this is at price P = AC observed above. At this point, the natural monopoly is making no losses and no economic profits (Pettinger, 2012); the profit made is normal. However, we can observe that there is a dead weight loss since there is a reduction of output from the efficient level and increase in price from the competitive price. Pettinger also noted that Average cost pricing is applicable mostly in competitive markets since it ensures that the profit made is normal profit. He argued that estimation of a firms average cost is a difficult task as it includes all the costs facing a firm (the total costs of a firm). This is different from the marginal cost that only involves the variable costs. On other words, this pr icing strategy is referred to as sales maximization which is contrary to profit maximization. The goal is to ensure that the market share is increased. The first customers are charged a higher price P1 and the natural monopoly makes a huge economic profit represented by the area named profit on the above diagram. The next set of customers are charged the efficient price P2 and the monopoly makes a profit represented by the area named Loss. When the analysis is done by combining the two areas, the natural monopolies profit may be zero or positive. So far, this seems to be the only pricing strategy where the natural monopoly have a possibility of making an economic profit while still under regulation. There are several instances where the government should allow price discrimination.e.g. For peak load pricing. Peak Load Pricing This is a form of price discrimination where the basis in not on market locations but on seasons or business cycles. The resources for producing goods are limited and thus sometimes the demand in the economy exceeds the quantity supplied (Schindler, 2012). There are many factors that could stimulate demand in certain periods such as climate management. The demand for a certain product may be high during the summer and lower during the winter. The excess demand will create a shortage which could only be eliminated by raising prices so as to discourage some demand in order for an equilibrium between demand and supply to be obtained (Knieps, 2015). In order to avoid the problem of excessive demand over supply, the government should allow the natural monopoly to raise the price during these peak seasons. However, the government should ensure that the prices are lowered during the low demand season again to prevent the issue of oversupply. This strategy is mostly used in utilities pricing e.g. electricity (Moschandreas, 2000). The demand for electricity is lower during the day and thus an excess supply over demand. The price charged during the day are thus maintained at a lower level. During the night, the demand for electricity is very high and thus a higher price is charged to limit the excess demand. Some of the other areas where peak load pricing is practiced is on the postal services, hotels, telecommunication industry, resorts, movies theaters, bars and clubs, restaurants, etc. Conclusion Price discrimination is the best pricing strategy for a natural monopoly as it would boost the social welfare since the price charged in the markets is only what a consumer is able to afford. This pricing strategy is better than all other strategies; this is because regulations by the government may be costly for the government, or may be more beneficial to some consumer group and a disadvantage to other consumer groups. For instance, those earning big incomes would benefit much buying at the efficient price whereas it would be costly for the government to subsidize the losses incurred. On the other hand, average pricing may also benefit those earning big incomes, save the government its subsidy costs, but would be a disadvantage to those who earns small incomes as they will be forced to pay a price greater than the efficient price. The question is; will the natural monopoly employ fair pricing if allowed to price discriminate? We know that they are bound to deviate from this strategy and charge higher prices also to those will small income. The government could set up conditions for price discrimination of which should be monitored regularly to ensure that the natural monopolies charge fair prices in all the markets through price discrimination. While it is believed that the natural monopoly would be more efficient if employed price discrimination and produced the efficient output, government regulation is crucial in ensuring that they do not deviate from this strategy by becoming profit-oriented. The fair price regulated on natural monopolies are still inefficient as the optimal competitive level of output is not achieved; the fair price is P = ATC. The natural monopolies depend on the subsidies the government provide when they are regulated to operate at a price equal to their marginal cost. There are challenges in using the Average Cost Pricing since the calculation of the total cost for a firm which is used in estimating the ATC is a difficult task. The government cannot rely on the information provided by the natural monopoly as it may be manipulated and thus should consider using other pricing strategies identified in the paper. References Bragg, S. (2017). Marginal cost pricing. AccountingTools. Retrieved 31 August 2017, from https://www.accountingtools.com/articles/2017/5/16/marginal-cost-pricing. Econ.iastate.edu. (2017). Regulation of Monopoly. Econ.iastate.edu. Retrieved 30 August 2017, from https://www2.econ.iastate.edu/classes/econ101/choi/ch13monD.htm. Greer, M. (2012). Electricity marginal cost pricing: Applications in eliciting demand responses. Waltham, MA: Butterworth-Heinemann. Hanks, G. (2017). Examples of Marginal Pricing. Smallbusiness.chron.com. Retrieved 31 August 2017, from https://smallbusiness.chron.com/examples-marginal-pricing-69593.html. Hill, A. (2017). Natural Monopoly in Economics: Definition Examples. Study.com. Retrieved 31 August 2017, from https://study.com/academy/lesson/natural-monopoly-in-economics-definition-examples.html. Kelly, Jenny. (2012). Natural Monopoly. Kellyandjenny. Retrieved 30 August 2017, from https://kellyandjenny.wordpress.com/2012/01/15/natural-monopoly/. Knieps, G. (2015). Network economics: Principles - strategies - competition policy. Cham: Springer. Moschandreas, M. (2000). Business economics (2nd Ed.). London [u.a.]: Business Press. Pettinger, T. (2012). Average Cost Pricing. Economicshelp.org. Retrieved 31 August 2017, from https://www.economicshelp.org/blog/glossary/average-cost-pricing/. Riley, G. (2015). Explaining Natural Monopoly. tutor2u. Retrieved 31 August 2017, from https://www.tutor2u.net/economics/reference/natural-monopoly. Sanandres.esc.edu.ar. (2017). Marginal cost pricing. Sanandres.esc.edu.ar. Retrieved 31 August 2017, from https://www.sanandres.esc.edu.ar/secondary/Marketing/page_150.htm. Schindler, R. (2012). Pricing strategies: A marketing approach. Thousand Oaks, Calif: Sage Publications, Inc. Stein, R. (2017). Natural Monopoly: Regulation through Average Cost Pricing. Coursera. Retrieved 31 August 2017, from https://www.coursera.org/learn/microeconomics-part2/lecture/bBnuG/3-1-7-natural-monopoly-regulation-though-average-cost-pricing. Velasco, Z. (2014). Monopoly. Slideshare.net. Retrieved 30 August 2017, from https://www.slideshare.net/oOvaniLLaOo/15-monopoly-1.