Discuss about the Monopoly for Regulation of Natural Monopoly.
An uncommon firm or enterprise which maintains exclusivity in the supply of goods is said to have features of monopoly market. Monopolies are governed both at national and international level via institutions known as WTO (World Trade Organizations).
The largest producer will generate lowest production prices generally through economies of scale or economies of scope as there is only one producer in the market (Arnold, 2008). This terminology is defined as Natural monopoly (Arnold 2008).. There are no close substitutes of products available in the market so the buyer has no option to switch to alternative products.
From regulatory point of view, if a single firm acquires more than 25% share in the market it is considered to have monopoly power (Dwivedi 2012).
There are few examples of natural monopoly i.e. railroads, electric power transmission system, natural gas and other industries that have large economies of scale.
Natural monopolies usually earn high financial incentive to misuse their market position in order to increase profits and power enhancement.
Price advantage for Natural Monopolies can be explained with the help of a diagram:
A Natural monopoly is a situation where multi-firm production is more costly than a single firm production (Baumol, 1977).
Why natural monopolies arise?
The essential cause of monopoly is the survival of barriers to entry.
Barriers to entry have three forms of origin:
- Authority is given by the government to produce exclusive goods
- Effectiveness of one single producer in the cost of production rather than having large number of producers.
Forms of Natural Monopoly:
- Regulated Natural Monopoly
- Unregulated Natural monopoly
The monopolist can enhance its profits by generating the quantity of output, where MR = MC. This is known as unregulated natural monopoly. The outcomes of unregulated natural monopoly are:
- Taking advantage by over-charging the customers
- The Monopoly power lies in the hands of one seller
- Unethical resource distribution
- Operational wastefulness
To bring unregulated Natural monopoly under control natural monopolies must be regulated.
- There are fair chances that a firm may incur economic loss, if an organization is regulated to produce optimal quantity of output
- Government should provide subsidy to the firms in-order to eradicate economic loss
The key features of monopoly market structure are listed below:
- Lack of substitutes
- Barriers to entry
- No competitor presence
- Price Maker
- Deciding the profits
Some of the advantages are as follows: Economies of scale: If a firm produces at Q2 its average cost will be AC2. A monopoly can increase output to Q1 by lowering down the average cost of the firm. Industries with high fixed cost can tend to survive in monopoly rather than small firms. Research and development: The super-normal profits can enable to spend more on research and development leading to better quality of products (Trembley, 2012) Source of Revenue for the government: The government gains revenue in the form of taxes from the monopoly firms. Huge profit making opportunity: Monopoly firms tend to earn huge profits due to absence of competitors. Stability of prices: As there is only one firm existing in the market stability of prices is assured to the customers. In a monopoly firm there is little or no competition prevailing.
Few disadvantages that include the following: Exploitation of consumers: As there are no substitutes available for the products, the firm may exploit the customer in terms of pricing, quality and quantity. The firm takes the advantage of producing inferior quality products as no competing products are available in the market. (Dransfield,2013) As the firm produces low quality products customers are dissatisfied with the quality of products being offered in the market. As there is single firm prevailing the market, the monopoly firm takes the advantage of charging different prices from different customers (McEachern, 2017). As there is no competition in the market the monopoly firm is willing to produce the goods of inferior quality.
Government regulates the prices because, If there are no government regulations the monopoly markets will charge price above competitive equilibrium which will create dissatisfaction amongst the consumers. The government assures the common public that the minimum quality standards of service should be maintained. (Morton & Goodman, 2005). A firm can exploit monopsony buying power if it has monopsony selling power. For example supermarkets can squeeze profit margin of the farmers by making use of their dominant market position. In some industries government intervention is less which can help to encourage competition. There are some industries which act as natural monopolies due to high economies of scale. In such industries government regulation is of utmost importance and competition cannot be promoted. Selling a number of products together in a single bundle is termed as bundling. The firms can be forced by the regulators to unbundle their products and open up their infrastructure. To bring monopoly under the control of the public is a less popular alternative available. In other words to nationalize is a better way out.
There are basically three methods to control the situation of monopoly in the market i.e.
By regulation through taxation – The government can impose taxes on per unit basis or lump-sum tax can be charged irrespective of output.
The impact of imposing specific tax leads to:
- Reduction in Output sold
- Price increases, which leads to burden on the customers in terms of levying tax.
- Reduction in profit margin
- It depends upon the elasticity of demand and supply, that the monopolist decides to shift the burden of tax onto its consumers
By law and guidelines of conditions of monopoly, as in case of natural and regulated monopolies – The essential services like water supply, power supply, transport facilities etc are categorized under public utilities. These services should be made available to the public at affordable prices.
In order to prevent unfair price discrimination amongst different consumers proper laws and procedures has been followed – This is the case of price discrimination peak and off peak supplies at different prices.
The following evil has been identified by the growth of monopoly:
- The weaker section of the society is the most impacted
- The Initial monopolies have more of an absorbing than spreading effect
- Due to undue concentration of economic power, the economic growth is impacted
- Monopoly leads to the growth of inequalities
- It has the power to corrupt
- Influential for taking economic decisions for the government
- Misdirection of resources is also regarded as evil of monopoly
The Monopoly enquiry commission failed to comprehend the nature of the concentration problem. Big businesses have also succeeded in attracting foreign collaboration. Thus monopolies are regarded as engines and consequences of growth.
There can be a substantial threat to free markets and their consumers with consolidation into one sole proprietor. Monopolies are generally regarded as illegal entities. To maintain competitive equality a number of strategies has been adopted listed below:
Average cost pricing, The regulatory approach applied fixes a price for the product or service beyond which charging cannot be done to the customer. The price that is fixed covers the overall cost which the company has borne on its production. The government created regulatory authorities such as :
- OFGEM – Gas and electricity markets
- OFWAT – tap water
- ORR - Office of rail regulator
The prices can be controlled by using the formula RPI-X i.e. Let us suppose X is the price by which they have to cut the prices. If the Inflation % is 4% and X = 2% then the price increase cannot be more than 2%.Price Ceiling, Another alternative way to control natural monopoly is through enforcement of maximum price potential that can be charged. Regulation of Rate of return: This concept is almost similar to average cost pricing. In order to ensure compliance with the regulatory approach the net profit earned by the company must be below the government specified percentage. The organization which employs accounting rules for calculation of operating cost, allows the firm to cover this cost and earn fair rate of return on investing capital. By providing financial support to the new entrants in the form of subsidies government can help to maintain competitive environment. For the large players in the market government can levy taxes in order to maintain equality. In monopoly market the regulators can examine the quality of service which are there as per the regulation authority. For example the electricity department ensures that senior citizens are treated with concern and there is minimum cut off in gas supplies in winters. Any new merger which takes place with more than 25% market share can be investigated anytime by the government so that they do not acquire monopoly power and are referred to competition commission for approval of merger.
There are cases where the government feels that monopoly of the particular firm needs to be broken as it is becoming powerful and gaining market share. For example this happened with Microsoft in US, but later on their decision was changed.
Government can break up natural monopolies in case of extreme criticalities.
Generally the free markets are at risk by the concept of monopoly. There are pre-requisites where natural monopolies are either useful i.e. they are cost effective or the situation is unavoidable. AT&T is an example of Monopoly where the government supported the firm in the 20th century, as investment of land line phones were considered substantial at that time. The government recognized monopoly until 1984 when AT&T was divested.
Formation of Monopoly can form a variety of reasons as stated below:
- If the ownership lies with one firm of scarce resources i.e. Microsoft (Windows operating system brand). The firm can exploit the consumers very easily as gains the advantage of having the monopoly power.
- In the year 1654 Oliver Cromwell gave monopoly status to the Post Office. In the year 2006 Royal mail lost its Monopoly status
- The suppliers of goods may have patents over design, or copyrights of ideas, images, sounds or names.
- By merging two or more firms together a monopoly can be created. No doubt this will reduce competition but will be subject to close supervision and regulation. The regulatory outlook can be avoided if the firm acquires more than 25% share.
There are several ways to reduce monopoly power or control the situation of monopoly including price controls and merger prohibition.
It is self explanatory that cost to the society arising from monopolies is much wider than the benefits and that monopolies should be regulated.
If there is high market concentration of one firm, it does not convey that there is no competition presence. The firm could be providing better quality goods and services and can prevail in the market more efficiently.
Secondly where there are increasing economies of scale, the natural economies tend to occur there. In such a situation it is more competent for one firm to supply the goods in the market instead of many small firms. This monopoly would be able to fully exploit the economies of scale and achieve highest level of productivity.
The firms who hold monopolistic patents are credited with advancing leading edge technologies and moving the technology forward.
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