Discuss about the International Trade for Theory and Policy.
According to Blau, Ferber & Winkler (2013), Natural monopolies are considered the largest suppliers in the industry. These suppliers are the most efficient ones in the production of the particular goods or services sold. The scale at which a natural monopolist produces is quite large, which further provides them with the opportunity of cost advantage over the other producers. Hence, the industry in which the natural monopolist operates finds it beneficial to allow that particular firm to supply the entire market at a lower average cost than two or more firms together. The government or some government regulatory board normally sets the prices for the natural monopolist (Browning & Zupan, 2014). In order to analyse the mechanism followed by the government while setting the price of the natural monopolists, this essay provides a clear view of the theories related to perfect competition, monopoly and natural monopoly. This would help in analysing the various aspects that is used to formulate the mechanism behind the pricing system of natural monopolist.
Forms of market, difference between perfect competition and monopoly and their profit
There are various forms of market structure depending upon their characteristics or attributes. Among the various forms of market, the two extremes forms are perfect competition and monopolist. Under a perfectly competitive market, there are a large number of buyers and sellers in the market selling homogenous goods. As the goods sold by the sellers are homogenous, there is a fixed place given to the firms, depending upon the market demand and supply framework of the industry (Case, Fair & Oster, 2014). Hence, it could be stated that perfect competitors are price takers who have the complete knowledge regarding the work. On the other hand, under the monopoly form of market, there is one seller in the market and a large number of buyers. As the supply of the products in the market is totally under the hands of one seller, hence, he is a price maker. A monopolist practices price discrimination in the market. In a perfect competitive market, the firms earn normal profit in the long run. It is so because there is possibility of free entry and exit in the market (Nikaido, 2015). Hence, it could be stated that the perfect competitive market results in greatest amount of economic surplus. Yet, it is always found that a monopolist would produce less and charge a higher price in the market for producing the same good or service as that of the perfect competitor firm. This can be illustrated with the help of the following diagram.
In figure 1, it is seen that a perfectly competitive firm was producing Qc amount if quantity at price Pc. The price and quantity has been analysed by the interaction of the demand and supply curve of the particular product. When, the perfectly competitive firm changes into a monopoly firm, the demand of the firm is no longer perfectly elastic in nature. The demand curve faced by a monopolist is a downward sloping demand curve. Equilibrium in a monopoly firm is achieved when the marginal revenue curve intersect the marginal cost curve. The equilibrium output produced by the monopolist is Qm whereas, the price is fixed at Pm. It is clearly noticed that the price charged by the monopolist, Pm is more than the price to be charge by the perfect competitive firm, Pc. Moreover, the quantity supplied by the monopolist, Qm , is comparatively lesser than the quantity supplied by the perfectly competitive firm. This thereby proves that when a firm, changes from a perfectly competitive framework to a monopolist, there are considerable chances of earning profits in the industry (Perloff, 2016).
Inefficiencies in monopoly
It can be easily interpreted from above, that a monopolist firm produces much less and charges a higher price for the same product. Hence, it can be stated that monopoly causes a reduction in consumer surplus, and an increase in the producer surplus. Hence, it is quite evitable to state that there is a reduction n the economic efficiency under a monopoly form of market (Eaton, Allen & Eaton, 2012). This can be said due to the presence of deadweight loss in the market. Allocate inefficiency occurs in such a market. This effect could be explained with the help of the diagram below :
In figure 2, the equilibrium point of a monopoly firm is at the point where MR=MC curve. Corresponding to the equilibrium price in Pm and the equilibrium quantity is Qm. If it were a perfectly competitive market, the firm would have been producing a quantity of Qc at price PC. This shows that the consumer would have to pay much lesser to a perfectly competitive firm than that of a monopolist firm. It could be stated that there is a reduction in consumer surplus equivalent o the area of the rectangle A. Correspondingly, with the fall in the quantity of goods to be produced in the economy, there is a considerable amount of deadweight loss, equivalent o he area B and C (Stiglitz & Rosengard, 2015). Hence, it can be stated that a monopoly firm increase the inefficiency in the market.
Regulation of Natural Monopoly
Natural monopoly occurs when the number of firms in the industry is singular in terms of efficiency. Firms who are accounted as natural monopolists have high fixed costs. It is often efficient for the industry in such situations to have just one firm producing the good. Increase in the number of firms would raise the cost of production and earn supernormal loss (Salvatore, 2012). In order to understand the case of natural monopoly, the following diagram is taken into consideration.
In figure 3, it could be seen that the industry demand is Q2, where only one firm is approachable with a minimum average cost in the long run. Other firms are able to produce only Q1 amount of goods at a cost of C1. This is due t the difference in the economies of scale. Hence, it is advisable for the industry to utilise one firm n place of many to supply the appropriate amount of goods at minimum average costs.
Natural monopoly faces no competition, hence they are considered as incontestable. It could simply be extracted from the stated fact, that due to its large scale of production, it could exercise market power over the others ad thereby set higher prices from the consumers as being a monopolist in the industry (Frank & Glass, 1991). Hence, in order to overcome such a situation, the government regulates a natural monopolist. Regulation of the government in natural monopolist could be explained with the help of the figure below.
In figure 4, a natural monopoly that is not subject to government regulation will charge a price equal to PM and produce QM. At this level, economic profit would be equal to the area marked as profit. If government regulators want to achieve economic efficiency they will set the regulated price equal to PE and the monopoly will produce QE, where price is equal to marginal cost. Unfortunately, PE is below average cost and the monopoly will suffer a loss shown by the area of the rectangle marked as loss. As the monopoly will not continue to produce in the long run if it suffers a loss, government regulators set a price equal to average cost, which is PR in the figure. In this manner, the government would be able to set a price that would produce neither loss nor profit (Cooper & John, 2013).
Monopolistic form of market
Under a monopolistic form of market, there are producers who sell differentiated goods. Product differentiation is considered as of the major aspects of the firms under this market. These firms compete with each other in three areas of quantity, price and marketing. Demand curve for such firm is equivalent to the downward sloping demand curve of a monopolist (Chopra, 2013). These firms incur additional costs of selling cost or advertisement cost in order to specify the differentiated characters of their products. The monopolistic firm aims at maximising its profit. It may earn profit in the short run, yet the profit gets eliminated in the long run. This can be explained with the help of the diagrams below :
In figure 5, the consumer’s willingness to pay is P1, and the producer must charge the price at minimum average cost curve, P3. Yet, due to the introduction of a differentiated product, the price charged by the monopolistic firm for Q kevel of input is P2. Hence, it earns a profit of the area marked as profit. This shows that the aim of the firm is to maximise profit during its course of production. This scenario is similar to the profit earned by the firm in the short. The short run profit earned by the firm is shown in figure 6. In figure 5, it can be noted that the firm has charged a price above the average total cost incurred y the firm. Hence, profit is earned.
In the long run, a monopolistic firm is not able to enjoy profits. This causes for the elimination of the profit that the firm had been enjoying in the short run. This can be explained with the help of the figure below.
In figure 7, due to the profit earned by the firms in the short run and the possibility of free entry and exit in the industry, new firms get attracted to the market. This causes a shift of the demand and the marginal revenue curves for the monopolistic firms. The equilibrium price in the long run attained is equivalent to the average total cost. Hence, there is complete elimination of the profits earned by firm in the long run
A natural monopolist, with its large scale of production is in its long run. Hence, it could be easily summarized from the above explanations, that a firm in its long run does not enjoy any form of profits (Yurukoglu & Lim, 2014). The price to be charged by the monopolist in the long run must be equivalent to the place where the demand curve cuts the average cost curve (Krugman, Obstfeld & Melitz, 2015). Hence, on regulating the price for the natural monopolist, a firm fixes the price at the point where the demand curve cuts the average cost curve.
Various market forms exist in the economy based on the types of products sold. Every market have their own attributes and characteristics. Natural monopoly is one such market form, where the existing firm is in its long run and hence has the capability of supplying the products in the market at a low cost. It is advantageous for the market to choose a single efficient firm, rather than many firms together. The government exercises the regulation of the natural monopolist. In order to obtain stability in the long run, the government fixes the price equivalent to the point where the average total cost curve intersects the demand curve faced by the firm.
Blau, F. D., Ferber, M. A., & Winkler, A. E. (2013). The economics of women, men and work. Pearson Higher Ed.
Browning, E. K., & Zupan, M. A. (2014). Microeconomics: Theory and Applications. Wiley Global Education.
Case, K. E., Fair, R. C., & Oster, S. (2014). Principles of Microeconomics. Pearson Higher Ed.
Chopra, A. (2013). CMP: INR1, 398 Buy. PAT, 2(3.2), 3-9.
Cooper, R., & John, A. A. (2013). Macroeconomics: Theory Through Applications. publisher not identified.
Eaton, B. C., Allen, D. W., & Eaton, D. F. (2012). Microeconomics: theory with applications. Pearson Canada.
Frank, R. H., & Glass, A. J. (1991). Microeconomics and behavior. New York: McGraw-Hill.
Krugman, P. R., Obstfeld, M., & Melitz, M. (2015). International trade: theory and policy. Pearson.
Nikaido, H. (2015). Monopolistic Competition and Effective Demand.(PSME-6). Princeton University Press.
Perloff, J. M. (2016). Microeconomics: theory and applications with calculus. Pearson.
Rader, T. (2014). Theory of microeconomics. Academic Press.
Salvatore, D. (2012). Microeconomics: theory and applications. OUP Catalogue.
Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.
Yurukoglu, A., & Lim, C. (2014). Dynamic Natural Monopoly Regulation: Time Inconsistency, Asymmetric Information, and Political Environments. In 2014 Meeting Papers (No. 530). Society for Economic Dynamics.