Economics Natural Monopoly

Question: Discuss about theEconomicsfor Natural Monopoly. Answer: Introduction Various forms of market exist in an economy. These markets are differentiated with respect to their attributes or characteristics. Among the various forms of market, natural monopoly is one such form of market, where a single firm has experienced monopoly. The firms are considered as one of the largest suppliers of the products in the market. They are regarded as the most efficient organization in order to handle the supply of the whole market. This helps in analysing the beneficial effect to the society and to the firm as well. Natural monopolist produces at quite a large scale which thereby provides them with the opportunity to produce the total supply of the market by being cost advantageous. The cost incurred in the market to produce the total supply of the market by two or more firms is quite larger than that of the natural monopolist (Browning Zupan, 2014). Hence, it is quite beneficial for the market to promote the existence of just one firm in the market. The government r a regulatory board of the government takes the initiative for setting the price of the natural monopoly products in the market. This essay provides a clear view of how government utilises various economical theories related to different forms of market, imperfections in monopoly, regulation of natural monopoly and how government plans to execute the process of pricing the products. These theories and government regulator implementation would be explained further with the help of an example taken on the Australian Rail Network. This would provide a better analysis on how the government plans to fix the price of the natural monopolist at the point where the demand curve cuts the average total cost curve. Analysis Forms of market, difference between perfect competition and monopoly and their profit In an economy, a market structure is analysed based on it characteristics and its competition with the other firms. Variation in the attributes of the market helps in framing a particular form of structure of the market, which provides an effect on its products, pricing strategies and competition with the other firms. Depending upon these attributes, a market can be stated as perfect competition or imperfect competition market. Under perfectly competitive market, perfect competitive firms exist. Under an imperfect competition market, monopoly, monopsony, monopolistic competition and oligopoly exists (Case, Fair, Oster, 2014). Among the stated names of the market forms, the two extreme forms of market are perfectly competitive firm and monopoly. Under a perfectly competitive market, the products that are produced by the firms are homogeneous in nature. The buyers and sellers in the market have complete knowledge regarding the product and the prices of the product, hence, each firm in such a market is a price taker. Under a monopoly firm, the firm is the sole proprietor of the market. The products that are produced by the firm are heterogeneous in nature, hence, they set the price of the product on their own will. A monopolist firm practices price discrimination among its customers. It could be stated that the perfect competitive market results in greatest amount of economic surplus (Chopra, 2013). Yet, it i s 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. Figure 1: Effect of Change of a Firm from Perfect Competition to Monopoly (Source: As Created By Author) In the above figure 1, the price of the products of the perfectly competitive firm is fixed where the demand and supply curves of the industry intersect each other. Hence, the price and quantity of the firm is fixed at Pc and Qc respectively. As the perfectly competitive firm is transformed into a monopoly firm, the demand curve of the firm is no longer inelastic in nature. The demand curve that is faced by the monopoly firm is downward sloping. The equilibrium point of the firm is achieved where the marginal cost curve of the firm intersects the demand curve. This results in the price of the product to be pm and the quantity to be Qm. It is quite easily visible from the following diagram that the perfectly competitive for there are m has to provide a quantity greater than that of the monopoly firm and the price charged by them is lesser than the monopoly firm . Hence, it could be stated that when a firm changes from a perfectly competitive framework to a monopolist, there are consid erable chances of earning profits in the industry. Inefficiencies in Monopoly A firm that belongs to the monopoly from f market charges higher price for a lower quantity of products to be supplied in order to attain maximum profit from the business. Hence, this shows that a monopolist firm reduces consumer surplus along with the reduction in economic inefficiency of the market. There is an existence of a deadweight loss in the market (Cooper John, 2013). Hence, it could be stated that the organization exerts social costs in the market thereby promoting certain inefficiencies of the market structure. The inefficiency of the monopoly form of market can be illustrated with the help of figure 2. Figure 2 : Inefficiency In Monopoly Market (Source : As Created By Author) In figure 2, the firms equilibrium is at the point where the marginal cost curve intersects the marginal revenue curve. The equilibrium price and quantity is pm and qm respectively. If it would have been a perfectly competitive market, the price and quantity supplied by the firm would have been Pc and Qc. Hence, 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 to the area B and C. Under natural monopoly, the number of firms in the industry has been reduced to one. The firm who are acknowledges as natural monopolists are in their long run and have incurred high fixed costs. It is efficient for the market to have just one efficient firm. This would help in increasing the efficiency of the market. Yet, being a single firm in the economy, the natural monopolist charges a high price of its products, raising the inefficiencies of the market and incurring social costs. In order to control such a situation of analysing market power, the government or some other government regulatory body often regulates the natural monopoly firm. Government Regulation The purpose of the government intervention in the monopoly market is to reduce the social loss and increase the social welfare which decreases due to monopoly practices. Following the ideas of the Redmond (2013), it can be said that the producer operating in the natural monopoly market can increase the price of the commodity to such an extent that the social benefits gets reduced. Due to this, the consumers will also lose utility from consuming that commodity. The government intervenes in such cases and pushes the price down to counter the situation in the natural monopoly, as given in the figure below: Figure: Government intervention in a natural monopoly market. Source: As created by the author. According to the figure above, the monopolist who is operating in a natural monopoly market can produce at that point of output, where his marginal revenue (MR) and marginal cost (MC) equals. In other words the condition can be stated as MR = MC. Following this condition, the monopolist charges a price of Pm, at which Qm quantity is sold. In the views of Stiglitz (2015), this condition causes the society to incur a cost, which no market agents receive. This cost is also named as the dead weight loss. This loss incorporates the buyers losing a portion of their consumer surplus. The government balances this loss by creating a price ceiling, above which the monopolist operating in the natural monopoly situation, cannot charge the consumers. This price level benefits the both the buyers and the society as a whole. The monopolist also receives normal profit due to this. As stated by Scitovsky (2013), the government has the opportunity to stet the price to the point of output where the demand or Average revenue is equal to the producers marginal cost. This will make the producer supply Qe amount of commodity at the price level Pe. This is the efficient level of the market. Here the consumer can buy more commodity at a much lower price, and hence receives a huge benefit. On the other hand, the producer gets back his marginal cost following this price level. The marginal cost is associated with only the variable cost of production. Hence, following this price level the producer will not be able to cover his fixed cost. Therefore, in the long run, the producer incurs loss. This ensures that the social welfare is not maximized here as all the market agents are not getting benefitted at the Pe level of price. As stated before, the government goal is to set a price level which will ensure that the dead weight loss is decreased and the social welfare increases at the same time. So, if the government sets the price level at Pe, the social welfare is not increased at all as the producer incurs a loss which amounts same as his fixed cost of production. In the views of Schubert (2013), this situation will make the producer leave the market as he will not be able to cover his cost. The government can address this issue by creating the price ceiling which will make the producer operate at the output level where his average cost of production and demand or the average revenue are equal (AR = AC). This situation presents a price level Pr and the corresponding level of quantity will be Qr. This situation represents the market situation which is similar to that of a perfectly competitive market structure. Here, the price level is lower than the monopoly market, but higher than the efficient level. In other words, the situation can be presented as Pm Pr Pe. According to Lim (2015), at this level of price the producer will be able to cover both of his variable and fixed cost in the long run. The amount the producer will be supplying at this level of price is Qr which is greater than the monopoly level and lower than the efficient level. This can be written as Qe Qr Qm. The producer at this point of production enjoys the normal profit. The level of price is also reasonable for the consumers. The society also faces no dead weight loss, hence it can be said that this price-output level (Pr, Qr) represents a Pareto efficient situation, deviation from which will ensure social loss. The railway system of Australia, where the government has opted for privatization for some of the parts of the railways, presents a situation of natural monopoly. The government of Australia ensured that two private companies are not operating at the same zone, as it will reduce revenue, efficiency, and social welfare. According to Simon (2015), the government countered this natural monopoly situation with a decreased price level which increases the social welfare and balances the consumer surplus. The private companies are also enjoying more or less normal profit, which helps those to cover both their variable and fixed costs of production. Conclusion The natural monopoly advocates of a situation where no other can seller can enter the market without any active barriers creation process by the producer, due the cost structure in the market. The situation gives the producer the potential to abuse his power by making the price level very high for generating more profit. The government thus intervenes in the market and the production process. The governments goal here is to maximize the social welfare, reduce the dead weight loss, balancing the benefits for both the consumer and the producer. For this purpose the government sets the price at that point where the demand or the average revenue is equal to the average cost. The same situation is observed in the Australian railway system, where the government has opted for privatization, and then set the price at a Pareto efficient level. It benefits both the consumers and the sellers while increasing the social benefit and reducing the dead weight loss of the society. Bibliography Browning, E. K. (2014). Microeconomics: Theory and Applications. Wiley Global Education. Browning, E. K., Zupan, M. A. (2014). Microeconomics: Theory and Applications. . Wiley Global Education. Case, K., Fair, R., Oster, S. (2014). Principles of Microeconomics. Pearson Higher Ed. Chopra, A. (2013). PAT, 2(3.2). CMP: INR1, 398 Buy. , 3-9. Cooper, R., John, A. A. (2013). 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