The issue that has been highlighted in this particular project is the reasons behind the governments wanting to regulate the price setting of the natural monopoly. Natural monopoly is essentially a market condition in which a single seller is the only seller of a particular product or service in the market. The monopoly firm is generally the single firm that forms the entire industry. Hence, it can be rightly said that the monopoly industries are the price makers and not the price takers of the industry.
The formation of a monopoly industry is influenced by certain factors like the government creating the barriers for new entrants in the monopoly markets. The firms dealing in scarce resources also lead to the creation of a monopoly market. The situation in which a particular firm deals in some intellectual properties, like patents or copyrights, also leads to a monopoly firm. The strong network with the supplier of the raw material also leads to the formation of a monopoly firm. Under a perfect competition market, the output and price determination is some-what different from that of the output and price determination of the monopoly market.
The above graphs depict the interaction of the supply and demand curve thus, determine the quantity and price to be produced under the perfect competition market and the monopoly market. In a perfect competition environment the availability of a large number of firms in the market, make them potential price taker and not price makers.
The monopoly price is, in all probabilities, determined by the seller itself. The seller effectively controls the supply of the particular product, thus, control the demand in the market.
The most important point to be noted in the case of a monopoly market is that the seller tries to maximize the profit obtained by him at MC = MR. The downward sloping demand curve is very effectively the average revenue and the curve of the marginal revenue lies below the demand curve. Therefore, as the price rises, the demand falls.
On the other hand, in perfect competition, the intersection of the demand and supply curve will very effectively determine the quantity and price. But, in monopoly, the marginal cost curve is the supply curve and thus, the exact point where the marginal cost curve cuts the marginal revenue curve effectively determines the price and quantity of the product.
Hence, natural monopoly is that type of monopoly in which the economies of scale is so huge that a single firm can provide the entire market at a lower average cost than that can be produced by two or more firms. The electricity supply in Sydney is a perfect example of natural monopoly.
The following reasons that make the government essentially regulate the price setting in the monopoly market are:
- Price – tendency of the monopoly firms to increase the price of the products
- Quality of the service or product – tendency of the monopoly firms to produce a large quantity of products in order to maximize the profit may lead to the firms compromising with the quality of the product. This also requires required government intervention
- Single seller – the availability of a single seller leaves the consumer with a limited choice that is they have no other alternative option other than to buy that particular product from the seller. Thus, this requires enough government intervention in regulation of the price setting in order to make sure that the monopoly firm does not exploit the consumers
- Output Restriction – the monopoly firm may also control the forces of the market by restricting the output of the product in the market
Therefore, as it can be understood from the above mentioned analysis the regulation by the government is very much needed as government intervention is the only solution in case of a monopolistic firm. As a monopoly firm enjoys the position of a sole seller in the industry the monitoring or supervision by a regulating body by the government is very much needed because in the absence of such a control the firm may misuse the power they hold over the consumers. Further, the following diagram simplifies understanding of the entire phenomenon of government regulation.