Understanding Natural Monopolies And Government Regulation

Regulating Prices of Natural Monopolies

Question:

Discuss about the Operations of Natural Monopolies.

Essentially, natural monopolies exist due to the existence of high entry barriers for other firms into the industry thus creating a single producer of goods and services with no close substitutes. Regarding regulation of natural monopolies there is need to properly understand market structure of natural monopolies, analyze merits and demerits of this market structure and its relevant theories. Also, it is important to illustrate the methods used by government to regulate the operations of natural monopolies. Moreover, it is vital to understand how the government enforces its regulation to achieve the desired regulatory goal. Equally, it is important to understand why the government considers it necessary to regulate the operation of natural monopolies.

Undoubtedly, government regulation of the optimum prices for natural monopolies is vital for consumer protection and welfare. Noteworthy, most governments have incorporated taxation as a way to regulate the price of goods and services offered by natural monopolies in the sense higher taxation is placed on higher prices of goods and services(Boundless,2017) Additionally,price ceiling has been implemented by most governments to contain the prices of monopolies in that the government sets a price limit for a given good or service thus curtailing the freedom of natural monopolies from charging excessive prices(Welker,2013). The government creates a maximum price that sellers can charge for their goods and services. Consequently, this leads to the regulation of the price charged by natural monopolies.

Further average cost pricing which reduces the flexibility of firms to set their own prices is considered effective in regulating pricing in monopolies. For some natural monopolies, the price of goods and services are typically low due to the fact that average total production cost continues to decline over a period of time(Pettinger,2012)Further, low cost are boosted by the fact that there is a fixed cost hence a natural monopoly can operate without competition thereby maintain considerably lower prices thus no need for government price control measures (Open Text, 2017)However, there will be need for government to maintain  anticompetitive measures for other firms to deter competition for natural monopolies who might otherwise raise their prices in the event of competition.

Also, government ownership of natural monopolies keeps prices in check in the sense that the goal of operation will be public interest and consumer protection rather than profit maximization which might trigger exploitative prices(Spaulding,2017).The government can naturally monopolies necessary services such as water and electricity supply so as to be able to avail the services to most citizens, the rich and the poor due to affordability capabilities .Also, price floor  have been implemented by various  governments to ensure natural monopolies make a substantial profit and at the same instance  protect  the consumers through setting of minimum price for commodities and services. Price floors are meant to help business make profits despite minimum prices.

Methods Used by Governments to Regulate Operations of Natural Monopolies

Additionally, price caps have been used to control the price of goods and services for consumer welfare (Tejvan, 2017) Usually price caps are determined by regulatory bodies. Through price capping,monopolies are forced to adopt prices way below the set price over a given period of time (Open Text, 2017).Usually, price capping encourages significant price drops of goods and services over a given time frame. For instance, most economies have water and electricity regulatory bodies under the government which decides the maximum price. Predominantly, regulatory bodies are meant to control the price of commodities. Also, yardstick or the rate of return approach is used to regulate prices in that the size of the monopoly is considered with the optimal profit from the capital such that in the case of excessive profits ,price cuts are implemented(Tejvan,2016)Usually, yarding allows monopolies to cover their cost of operation while having substantial returns .

Predominantly, legislation has been used to regulate various business activities and pricing for goods and services is no exception. Most economies have enacted price regulations Acts and guidelines to guide monopolies and other firms in other market structures such as duopolies, on the minimum and maximum price for goods and services. For instance, the Independent Republic of Papua Guinea,has enacted the Prices Regulation Act (Chapter 320) of its National laws(Independent Commission for  Consumer and competition and Commission 2017)Most government have statutes regulating the prices of goods and services ,most specifically ,there are acts of parliament on utilities. Usually utilities include services such as water and electricity.

Largely, the non-existence of natural monopolies through encouragement of competition from other industry players by government through  relatively low barriers will reduce monopoly power over price control thus regulating price of goods and services.In the event that there’s perfect competitive market according to the concept of perfect competitive markets, then there’s consumer sovereignty as opposed to monopoly power under natural monopolies .Natural monopolies are price setters as opposed to price takers in perfectly competitive markets. Ideally, perfect competitive markets are the best market structure. In the event that natural monopolies are eliminated or unable to exist, then it follows naturally that there’s no need for regulation by government .There’s need for government to establish competitive business environment to balance out market structures.

Alternatively, price control for monopolies can be regulated through marginal cost pricing which requires that all natural monopolies to produce goods and services where the quantity of goods supplied touches the demand curve thus setting the price for the commodities and services produced by the natural monopoly (Open text,2017) Through marginal costing, consumers are assured of surplus at considerably lower prices.Further, there’sallocate efficiency for firms adopting marginal cost system of pricing attributed to the marginal cost of goods incurred in production of the quantity supplied.Additionally, cost plus regulation whereby government set price levels over a given period of time through addition of normal profit rates to accounting costs of the firm has been adopted.

Regulating Other Firms to Deter Competition for Natural Monopolies

Lastly, the implementation of a government based deficiency scheme of payment will for a long way in reducing the price of goods and services offered in the market and the same goes for natural monopolies (ILRI, 2017)Through the deficiency scheme of payment, producers of a good or services are given compensated profits on condition that they charge low prices for consumer welfare. Moreover, there’s a consumer subsidy which is aimed at boosting consumption at considerably lower prices with no impact on natural monopolies(ILRI,2017)A consumer subsidy reduces the prices for goods and services thus making them affordable for the consumers. The subsidy is offered by the government to its citizen for domestic consumption and benefits.

Essentially, governments may regulate the price of goods and services to protect consumers from exploitative prices  in that without regulation, natural monopolies will set higher prices to maximize profits which ends up hurting the consumers(Tejvan ,2016) .Further, regulation of natural monopolies is done to avoid or reduce allocativeinefficiencies for natural monopolies(Stanbury,2015).Perfect competitive firms are likely to experience allocative efficiency as compared to natural monopolies(Tejvan, 2016)Economically and theoretically, perfect competitive markets are ideal for consumer welfare and are considered economically and allocatively efficient as contrasted with natural monopolies.

Further, Monopolies are regulated to prevent abuse of power(Pera, n.d).Typically, monopolies are price setters thereby making consumers price takers. Typically, profit maximization being the main goal of operating an enterprise, natural monopolies are likely to charge the highest price for goods and services in the absence of government regulation(Bigger, 2008) In addition, monopolies are regulated for quality assurance reasons. Due to the existence of a monopoly, the firm might not fulfill the minimum quality standards hence the need for government to intervene and ensure that the quality of goods and services to be observed.Also, throughregulation, deadweight loss is eliminated according to the deadweight loss hypothesis thus the ad vocation of marginal costing to regulate monopolies (Bigger, 2008)

In addition, regulation of natural monopolies is vital in creating competition and providing an equal footing for other firms in the industry(Brink of Economic thoughts,2017).Lack of competition,leaves consumers at the mercy of the natural monopoly and other firms who would otherwise venture into that industry are prevented to by high entry barriers and other advantages enjoyed by natural monopolies(Amir,2015) .Further,natural monopolies undermine consumer choice and sovereignty due to the lack of variety or substitute goods or services and price setting power respectively(Economics Online,2017)More so,the ability of monopolies to regulate their  output may be abused  through  limited supply thus denying consumer surplus in order to hike prices for profit maximization at the expense of the consumer .

Government Ownership of Natural Monopolies

Economic efficiency is also another motivator for government regulation in the sense that unregulated monopolies  are likely to have prices way above the marginal cost  and high production costs which is considered economically inefficient(Boundless,2017)Further, market failure motivate the need for regulation. Also, natural monopolies may depict high production costs just to deter entry of prospective firms into the industry in an attempt to maintain monopoly power over its market share. Perfectly competitive market structures are considered economically and allocatively efficient hence making them the ideal market structure whereas natural monopolies are considered inefficiently economic and allocatively thus the need for government intervention to promote efficiency.

Typically, quality assurance is vital for consumer welfare hence the need for government intervention in the operation of natural monopolies to ensure consumer get the best quality goods and services.Usually,without any form of regulation or monitoring,producers might get sloppy and greedy thereby producing substandard goods which are harmful for consumption(Knownai,2011)By and large,regulation of monopolies exists to protect smaller firms likely to enter the market dominated by monopolies(C.s. Stanford,N.d)in the case of regulation through windfall taxation systems, governments aim to encourage  reinvest of profits incurred by natural policies as opposed to payment of dividends to its shareholders .In a way ,regulation helps distribution of income between producers and consumer.

Through regulation of monopolies, restrictive trade practices and barriers are eliminated.Essentially, the existence of a monopoly is characterized by high operating cost, high entry barriers into the industry, large economies of scale among other factors thus the need for government regulation to allow entry of other smaller and upcoming firms (Investopedia, 2017) Natural monopolies deny other investors from entering its share of the market due to the various advantages it has over smaller firms. Smaller firms are unable to easily enter a naturally monopolized market as opposed to perfectly competitive markets.Ideally,consumer interests such as choice, variety and sovereignty are realistic in a perfectly competitive market as opposed to a naturally monopolized market thus the need for regulation.

Conclusion

Undeniably, there are concepts, theories and principles advocating for and against government intervention in the affairs of natural monopolies. Seldom do natural monopolies exist but they do. Majorly, Regulation is all about consumer surplus, satisfaction, choice, sovereignty and welfare as opposed to profit maximization .Regulatory measures are enforced by government based agencies and bodies, mainly through legislation. The most common ways of price control of monopoly power is through price ceiling, price capping, taxation, average cost pricing and marginal cost pricing.Most of these regulatory prices are considered not mutually beneficial for consumers and producers. Arguably, regulation seeks to protect the interests of consumers rather than natural monopolies or producers.

All in all, government intervention through regulation is faulted for the unforeseeable consequence of optimum price and output which is more theoretical than practical. Further, government regulatory body’s employees are considered a tax burden on ordinary citizens. Besides, natural monopolies rarely exist and if they do, they last for a short period of time thus making regulation not a full proof solution for market failure and inefficiencies. Nonetheless, the heart of regulation is in the right place as it seeks to protect the consumer, who is considered weak as compared to producers.Through regulation, most government strive to  achieve consumer protection and welfare while creating a friendly and competitive business environment as opposed to profit maximization which is considered ideal for most economies as compared.

References

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