Natural monopolies are favorable to businesses wherever the principal providers gain price rewards and have to be synchronized to diminish threats. Theoretically speaking, a natural monopoly is defined by a current in an industry wherein it is the highest supplier but even then has the capability to give a price which is the lowest with the help of economies of scale. Thereby those who are a part of this kind of a monopoly are always exposed towards creation of a higher risk of actual monopoly. However the society tends to gain by regulating these scenarios to even playing the field. Although the general concept is that monopolies are a threat to free market, however some kinds of monopolies such as natural one are either practically of use or almost inescapable. Thereby with the above definitions it seems clear as to why the government is inclined towards regulation of the price setting of a natural monopoly. The said essay discusses the reason and the method of the said regulation.
Monopoly is one type of a market structure which needs regulation and intervention of the government compulsorily as many a times the same may be misused by the businesses for their own benefits thereby conducting the business which is not for the good health of the society as a whole. Hence the government regulates natural monopoly too even though the same is not as threatening as the other forms of monopoly. Many ways are adopted via which a government may regulate the price setting in a natural monopoly such as price capping by regulators RPI-X, regulation of service quality, merger policies, breaking up a monopoly, yardstick or ‘Rate of Return’ regulation and examination of exploitation of domination command.
Various regulatory bodies were formed by the government for fresh privatized industries such as electricity. OFGEM is the body created for the regulation of electricity. These bodies help to ensure that the price increase is within permissible limits and the same is asked by them to do by the application of a formula names RPI-X wherein X denotes the price by which these industries are required to reduce the prices in real terms. However the said method has various benefits as well as flaws. The advantages amongst them are that th refulator has full authority to fix the increment in the prices with respect to the condition of the industry presently and the expected efficiency savings. Thus if a company reduces the costs more than X, they would in turn be able to gain more. Another very stark advantage is that of surrogate competition wherein the absence of competition, RPI-X is a method to increment the antagonism and avoid the misuse of the monopoly power. The disadvantages are however also to be taken into account. Firstly, it is quite an expensive affair to decide what would be the level of X. Further there is always a risk of a situation wherein the regulators may become inclined towards the favor of the company and thereby allow them to increase profits out of reach. Last but the not the least, the companies are generally found to be unable to maintain the efficiency savings simply because they may become too efficient and in turn be penalized because they possess higher levels of X (economicshelp.org. 2016).
Further to this price setting may be regulated by close examination of the kind of service being given by the monopoly such as in the electricity market, the regulators have to ensure that those who are aged are given special treatment such as not allow electricity to cut down the supply in summers. Thirdly, the regulators have full rights to check upon the various mergers which may lead to creation of monopolies, thereby ensuring to interfere and break them or allow them depending upon the kind of merger and the companies involved in the merger. Fourth and one of the most common ones is the breaking up of the existing monopoly when the regulator is of the view that the monopoly concern has become powerful enough to misutilize its powers for the detriment of the people. However the said way of regulation is a rarity as it is taken only in very extreme cases when the monopolist is behaving in an untoward manner thereby harming people (Joskow, 2007).
Fifthly, apart from the RPI-X methodology, there lies another way which also contributes to regulation of price setting in a natural monopoly. The Rate of Return regulation methods takes into account the size of the firm and appraises what would make an acceptable level of gain from the capital base. Thus it is rightly said that if a company is seen to make a lot of financial gain in comparison to the actual size of the firm, then in such a scenario the regulator may end up cutting the prices or levy a one time tax. However the flaw in the particular method is that it can lead to ‘cost padding’ wherein a firm is seen to give permission to increase the cost to such a level that the financial level of gain are not understood by people as excessive. It gives less motivation to be competent and augment financial gains. In addition to the same, rate of return regulation may not be able to examine the level of gains which would be considered to be rational. Hence if the same is set at a higher level then the firms may take undue advantage of the monopoly power.
Last but not the least, there are various investigators who if find the situation as such wherein they feel that the monopoly firm is misusing the power, then the same can be investigated. The unwanted actions may comprise of collusion wherein the firms are of the opinion to augment prices, collusive tendering of bids, predatory pricing wherein they would set the price at such a level wherein the competition gets wiped out in totality and selective distribution (Winston, 1993).
For example in the electricity business, a differentiation is found in the rates i.e. the residential and commercial rates are different. The said industry is categorized as a high fixed cost industry. Here the cost of producing a watt of electricity is extremely high, however as soon as the first investment is done, then the average costs gets reduced with every unit being produced. Competition in the particular industry is not welcomed by the society simply because the existence of a huge number of firms would lead to repetition of capital investment (Depoorter, 1999).
The market reforms which started off in the 1990s, there the government played a very crucial part in price setting for publicly-owned electricity authorities. Such as in Victoria and Tasmania wherein the electricity boards had the authority to fix the rates , however the same had to be approved or be adjusted y the government. In New South Wales, the person who was the then minister had the power to fix prices in consultation with the public enquiry. However when the electricity market reforms came into existence, the ultimate pries of electricity was not regulated . The generated price of electricity is unfettered and is fixed via the electricity pool basis the competitive bid for transmit. This has helped in the fall of the prices of electricity (treasury.gov.au.2015) .
It is very crucial to understand that in real scenario it is highly unlikely to find a ray of hope between industries that are ‘natural monopolies’ and those that fall under the captegory of ‘competition’. There lies various reasons as to why the government wishes to regulate the price setting of a natural monopoly. As is a known fact that if the monopolies are not regulated well, then it may lead to shooting up of the prices of the goods which may e detrimental to the health of the society specially for products which are of daily necessity such as electricity. However the said process may lead to allocative loss of efficiency and a reduction in the welfare of the consumers. Secondly, it is a necessity specially in case of services supplied by electricity firms, water suppliers etc that the service beign provided by them are of a high quality. If there exists a monopoly then the firm may take undue benefit of the said fact and end up providing a bad service. Thereby one of the main reasons behind government intervention is to ensure that the consumers are not required to comprise on the quality even after making payments as required (Hertog, 2010).
Generally it is perceived that those firms who are monopoly in the selling areas may also have the benefit of taking undue benefit of monopsony buying power i.e. to squeeze the financial profits of the sellers. Fourthly, encouraging competition also would help government to regulate as by doing so the firms will automatically shift from being a part of natural monopoly to being a part of competition market. The said attempt would in turn ensure that the government is not required to impose much of regulations. Also such an act would help in controlling the price increase and undue exploitation as well (Demsetz, 1968).
Further the intervention of government is seen in price setting of utilities such as electricity. The main reason is that it is inelastic in nature. If the government is not allowed to intervene in the pricing of the same, then it would lead to an unbalanced economy as the absence of the regulation would make the monopolistic entities increase their prices by a very high percentage. For example the state governments may be of the opinion that de-regulation of the electricity industry may help in reducing the prices substantially in the long run. The reason behind the same is that even if the presently, the firms may end up reaping in more gain but in the long run it is sure that newer firms would emerge leading to downsizing the profit of the present company. The electricity industry would branch out into various companies who would further ensure execution of prices which are competitive enough thereby beating the competition (Singh, 2015).
Electricity is one industry which falls into the natural monopoly and if the prices are not regulated then it would lead to a condition wherein the entire economy balance faces a hit. It is such a big necessity that people end up paying as demanded, hence is termed as inelastic. Thereby this way it is sure that the firms would make all attempts to misuse their power and augment the prices considerably. Last but not the least, the government specially in a democratic set up is ‘for the people, by the people and of the people’ and thereby the phrase makes it clear that the government’s job is to fulfill the requirements of its people wherein it has to ensure that it is fair with both the consumers as well as the firms (Kim, & Horn, 1999).
Conclusion
Thus on a concluding note, it is very clear that the regulation of the natural monopoly is also a must. The government is formed to serve the people of its country and one of the duty and responsibility is to ensure that regulation is imposed so that exploitation is prevented. Electricity being one of the most crucial utility, if not regulated may end up ruining the economy as well as people may end up spending more on it as it is a necessity which would in turn hit other industries. The methods are many and depending on the kind of exploitation that may occur, the government imposes regulation hence trying to cut the price and set it a level which is acceptable by all thereby ensuring that natural monopoly does not create an imbalance in the economy. Various ways although suggested, the one best suited as per the situation should be applied so as to ensure that the price setting is done to the best health of the country as a whole.
References:
Demsetz,H. (1968). Why Regulate Utilities? Journal of Law and Economics. 11(1). 55-65. Retrieved from https://www.sfu.ca/~wainwrig/Econ400/documents/demsetz68-JLE-utilities.pdf
Depoorter,B.W.F. (1999). Regulation of Natural Monopoly. Retrieved from https://reference.findlaw.com/lawandeconomics/5400-regulation-of-natural-monopoly.pdf
economicshelp.org. (2016). Regulation of monopoly. Retrieved from https://www.economicshelp.org/microessays/markets/regulation-monopoly/
Hertog, J.D. (2010). Review of Economic Theories of Regulation. Retrieved from https://www.uu.nl/sites/default/files/rebo_use_dp_2010_10-18.pdf
Joskow, P.L. (2007). Regulation of Natural Monopolies. Retrieved from https://economics.mit.edu/files/1180
Kim,S.R. & Horn, A. (1999). Regulation Policies concerning natural monopolies in developing and transition economies. Retrieved from https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.537.6168&rep=rep1&type=pdf
Singh,A. (2015). Economics in Power Markets. Retrieved from https://www.iitk.ac.in/ime/anoops/IEX%202015%20Training/IITK%20-%20PPTs%20-%202015/Day%20-%201%20IITK/1%20-%20Anoop%20Singh%20-%20Economics%20of%20Power%20Markets%20-%202015.pdf
Treasury.gov.au. (2015). Price Regulation of Utilities. Retrieved from https://archive.treasury.gov.au/documents/194/PDF/round5.pdf
Winston,C. (1993). Economic Deregulation : Days of Reckoning for Microeconomists. Journal of Economic Literature. 31(3). 1263-89
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