Dynamic Natural Monopoly Regulation

Question: Discuss about the Dynamic Natural Monopoly Regulation. Answer: Introduction: The subject economics deals with the basic notion of demand and supply. The entire subject with complicated mathematics, theories, decision-making processes deals only with the way in which equilibrium can be restored in the economy by matching these two components, the demand and the supply. The markets can be categorized into several parts. They are: Monopoly, Oligopoly, Oligopolistic, Monopolistic, Perfect competition and Monopsony. In this essay the four most important forms has been described followed by a details understanding of the natural monopoly market. Perfect Competition is the utopian yet ideal situation of market that any consumer wants(Makowski, 2014). In monopolistic market a few seller sells similar type of product and faces little impediment of exit and entry(Nikaido, 2015). Oligopoly market has few sellers who can individually influence the pattern of trade (Weyl Fabinger, 2013). The 4th type is the market of monopoly, a utopian concept. Monopoly market structure This market is characterized by a single seller. The single seller caters to a large number of buyers. It is a utopian situation. As there is absence of other sellers, hence the monopolist has the power to decide upon the price of the service and goods that he caters to the people. From the very basic concept, it can be said that there is impediment to enter the market (Scitovsky, 2013). Costs Benefits of the firm at average cost pricing: The natural monopoly market is now described in details to understand how the benefits of producer and costs of consumers are calculated to form the equilibrium. Natural monopoly is a situation where there is only one seller or producer of the goods (Lim Yurukoglu, 2015). The entry of other producers is debarred due to the lofty cost associated with the establishment of the set up where the goods will be produced. In other words natural monopoly exists for goods which require enormous fixed cost. Natural monopoly is different from pure monopoly in the sense that the in the former one distributing or allowing other company to produce the same good will lead to an enormous cost. In the later, other firms cannot operate as they are debarred from entering the market by the existing firm and its regulations (Stiglitz Rosengard, 2015). Some important characteristic that makes the market to be a natural monopoly are: Existence of Economies of Scale: The economies of scale imply the situation where there is a fall in the marginal cost of production with an increase in the number of total quantity of output produced. The fixed cost is very high: In any production process there is two types of cost, the fixed and the variable costs. The fixed cost is the burden that the company has to bear even if it does not carry on its production (Simon, 2015). The variable costs are relatively low: In natural monopoly this part of the cost is very low and the number of people taking advantage of the goods and services has negligible power to alter this variable cost. Increasing the number of producer increases the production cost as well as the wastages of the resources involved in production. E.g.: The service provided by the transport sector via railway is cost-effective as there is monopoly. If any other service provider tries to enter the market it has to bear a huge cost in the form of establishing the complex network of infrastructure. At the same time assuming that the number of people taking the service is constant, the consumer gets distributed amongst two service provider and it decreases their revenues. One classic example of natural monopoly market is the railway service which acts as one of the main method of communication and transportation in many countries of the world. Through the above figure, LRAC is the long run average cost curve of the natural monopoly firm. Under monopoly the demand of the firm and average revenue are same and can be depicted by the same downward sloping line. The government of any nation always tries to quote the price of the firm dealing with natural monopoly at the intersecting point of average total cost and demand curve (Hawley, 2015). The reason behind such a step can be highlighted on the basis of the following points: First, the effect on price, quantity produced and dead-weight loss when the monopolist is allowed to decide freely on the service that they provide. Secondly, the ideal situation of price and quantity that the consumer demands differ and the problems associated with the situation has been highlighted. Through the figure above, the situation that may occur if natural monopolists are allowed to work freely has been portrayed. Monopolist always tries to maximize their profits. The situation which helps them to maximize their profit is shown by the intersection of two curves namely the long run marginal cost curve and the curve showing marginal revenue (Stigler Mencken, 2016). If they are allowed to quote their price without any hindrance by the government, then the monopolist will charge a very high price as shown by Pm in the figure. At this high price, very few people will be able to afford the service and hence though there will be need for the service but the demand for the goods and services will be very less. The total quantity of goods produced will be very less as shown by Qm in the figure. This leads to loss of welfare in the society in the form of huge amount of dead-weight loss. The dead-weight loss is shown by the triangle ABC in the figure. On other hand the firm is also benefitted in several ways under this market structure. If they were operating with perfect power in hand they are ideally to produce less quantity. But under natural monopoly as the firm and the higher authority restricts the entry of other firms hence the firms are benefitted. In certain cases the firms are even provided with subsidy by the government as they are forced to provide their service at a lower cost. The people on other hand are benefitted as government intervention helps the price to be lower than they ideally should be. In natural monopoly if every decision is left on the monopolists hand there will be market failure. Hence, there is need to set up some price regulation in the market. In case of natural monopoly usually the government regulates the price by setting a restriction on the upper level that the monopolist may charge for the goods and service he produces. Needs for government regulation The situation when government tries to optimize the situation with respect to the societys perspective has also been shown in the above figure. Consumers always try to get goods and services at the minimum possible cost. In this situation, the consumers want the price to be as low as Ps. That is the consumer wants the price of goods and services at the point where the long run marginal cost intersects the demand curve. At this low price most of the consumer will have the affordability to pay for the services and hence the maximum demand will be generated in the economy. This may seem an ideal situation but the problem that lies in this situation is that the monopolist with their profit making motive will never want to produce at such a low price as it will reduce their profit to negligible point. At this situation the cost of production (LRAC) is greater than the revenue earned by selling the goods and services. The problem of allocative efficiency occurs from this juncture. Allocative efficiency implies the situation where there is a balance between the consumers demand and economys production. Under this situation the price that is average revenue should be equal to marginal cost. But in this scenario the natural monopolist denies to operate and henceforth, the government has to intervene and keep the price at an intermediate position. Hence, the ideal situation of the monopoly market should be something in between the monopolists choice and the consumers choice. This can only be ensured with the help of government intervention. The situation is described by the figure below: As already seen that monopolists price is very high i.e. Pm, whereas ideal price as demanded by society is very low at Ps. The government is responsible to its people for providing proper services and hence it intervenes in this market. It forces the monopolist to keep their price at the point where the total cost curve intersects the demand curve of the consumer. This point is better than the two extreme situations discussed earlier. At this point the monopolist is ready to continue their production as their cost is at least equal to the revenue. On other hand due to the comparatively low price required to pay for the service, many consumer can afford it and get benefitted. The loss of welfare has also been reduced to a great extent. In this case the dead-weight loss of the society is the part shown by triangle EFG. There are very few things that falls under the natural monopoly. In few countries the railway network forms natural monopoly whereas in some other country the industry catering for energy sources forms the monopoly. Recently the industry dealing with fiber optics has started operating in some markets and they enjoy the status of natural monopoly (Minamihashi, 2012). The reason behind considering railway network as natural monopoly is the high cost associated with it. In country like India and Australia the railway network is operated by the government of the respective countries (Nash, 2015). In India, the Ministry of Railways looks after the entire railway network and they are under the control of the Central government. In Australia, the federal government takes care of the entire railway network system through their corporation named as Australian Rail Track Corporation. The reason behind this scenario of mono-operated complex system is that there is huge direct and larger indirec t cost associated with the system. The direct costs are cost of constructing the railway track, assembling them, building the trains, establishing a well established network of communication system, maintenance cost and car sheds for the trains to rest during non-operating hours (Vikharev, 2013). The indirect cost associated with this system of transportation is that of clearing the way through which the tracks were laid, cost associated with relocation of people living in the area where the proposed railway track will pass through, etc. The Australian government in the year 2003 planned to invest around $872 million for building up an inter-state network (Miller, 2016). Now if any other company tries to enter the market they need to go through all these direct and indirect cost before entering into the market. The number of commuters cannot increase over night. As they remain same, hence if two firms operate separately in providing the service then the revenue that the first firm was earning will get distributed. As a result it may so happen that the revenue may get lesser than the cost of operation. Hence, it is better that some services should be provided by single provider only. Conclusion: This essay can be summed up by once again highlighting few points. Monopoly market leads to market failure and hence perfect competition is a utopian yet an ideal situation that can exist. But in certain situation natural monopoly is a preferred market as arrival of competitor leads to increase in the cost of production while decreasing the revenue. At certain times this situation can only be improved by havoc advancement in technology associated with the service. Railway is the common example of natural monopoly in many countries. The reason behind considering railway network as natural monopoly is the high operating cost associated with it. One single service providers can provide large scale of services efficiently with minimum cost of production compared to multiple firms. The essay has highlighted several costs and benefits of price regulation in natural monopoly market. It has been that a single firm can operate in a firm when that firm enjoys economies of scale over a long ran ge of quantity. 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