Question:
Explain how and why Governments may want to regulate the Price setting of a natural Monopoly.
Monopoly market structure operates as the sole supplier in the market (Arnold, 2015). They enjoy a large number of customers raising their product demand. They operate in a closed market, which other sellers are not able to enter the market and as a result, there is no competition in the market. The best way to analyse the market is to identify the market strengths and ability to influence supply and demand in the market.
The government has a role of controlling monopoly prices. This is because market forces such as competition do not affect them (Behravesh, 2014). Therefore, the government response in controlling monopolies is important by setting policies for monopolies. Customers are citizens who require the government protection and thus require protection from monopoly exploitation.
From an economics perspective, the issue of monopoly goes hand in hand with the issue of pricing of products. Monopolies make prices for their products and thus the customers lack the freedom of negotiating prices (Burda, July 25, 2017). Additionally, there is the issue of influencing product demand and supply of products. They are the sole producers and thus through their production decisions determine how much of a product they will take to the market. Therefore monopolies unless controlled by the government, they are capable of exploiting their customers.
Explanation
Point E represents the market equilibrium point before introduction of a price controlling measure such as taxes. The firm out is represented by OX while the price is OP.the firm earns profit represented by AB. However when the government introduces taxes, the average cost (AC) increases to AC1. The introduction of taxes raises the cost of production for monopoly firms. Consequently, the firm raises product prices in the market to recover added costs. The result is that the government should intervene to ensure maintenance of prices at equilibrium point (Flynn, 2011).
Monopoly market
This are markets formed by a sole supplier of a particular commodity. The commodities dealt with have characteristics that make them difficult for other sellers to enter the market. The characteristics are such as private ownership of rights to sell the products. Other monopolies formed by government policies, which allow to sole product sellers. These products are such as weapons and other items concerned with national security. Barriers of entry to market also creates monopolies. This includes such as high legal fees to enter a market, which other sellers cannot afford. Monopolies are thus a result of inability of other sellers lacking the power or resources to enter a market (Flynn, 2011).
Furthermore, monopolies lack competition in their markets (Jones, 2017). Their market due to the barriers to entry for other sellers lack competition. Competition resulting from other sellers dealing with similar goods lacks in the monopoly structure. Lack of competition causes monopolies to operate freely as there are no peers to compare operations or to take advantage of their market failures. This is a great advantage for monopolies due to the ability of doing what they want in the market without competition.
In addition to that, monopolies are price makers. This means that they have the freedom of taking products to the market at the prices they deem profitable (Lee Coppock, 2017). This separates them from other markets such as perfect competition, which are price takers. This refers to pricing of products based on the prices that the customers want to buy. Monopolies enjoy the freedom of setting any price for their products, which they feel, will cover fully for their variable costs and earn profit from sales. There is however, a tendency of monopolies setting very high prices to make exaggerated profits from sales. This act oppresses customers, as they have to pay too much for a product, which is usually more than the products utility. Monopolies require legislators to come up with policies that control the prices to stop high pricing. They are also able to practice price discrimination for their products. This is the sale of their products at different prices depending on the customers in a market or market trends. They sell large quantities of products at low costs in elastic markets and sell at high prices in inelastic markets. This they are able to do because of the free operation in the market.
Monopolies enjoy large economies of scale in the market unlike other markets such as perfect competition (Miller, 2017). This is the reduction in unit costs with increase in volume of production. This makes it difficult for competitors to enter the market due to high initial fixed costs and low unit costs. Competitors mostly are unable to raise the high initial fixed costs to enter the market. This is a benefit to a monopoly because they remain as the sole sellers in a market. There is also the ability of the monopoly to sell at very low prices compared to prices charged by entering new monopolies. These low pricing results to the new sellers not selling their products in the market as they charge high prices. The result is that they get out of the market leaving the monopoly as the sole seller in the market. They are able to price less because of the reduced unit costs for products with increase in quantity. Monopolies enjoy this advantage which enables them operate as going concerns for many years and earn super profits from their activities
Explanation
The firm maximises profits at the point where MR=MC and the equilibrium point where Pm intersects Om. The market demand curve is similar to the firm demand curve. The firm makes super profits because AR is greater than AC (Behravesh, 2014).
Why governments regulate prices for a natural monopoly
The government as the policy maker has a duty of regulating the prices of monopolies (Mankiw, 2017). Monopolies operate in an environment, which lacks the normal market forces to regulate activities. The forces of demand and supply regulate other markets operations but does not apply in monopolies. Demand for products in the market regulates how much of a product the sellers will bring to the market. When demand is high, then the sellers bring high quantities to the market to satisfy demand. On the other hand, when the demand is low, they supply less of the product to match low demand levels. This forces do not affect a monopoly because they have the freedom to choose how much of a product to sell in the market. They could choose to supply less products to the market when the demand is high. This results to the increase in the price for their products. The government thus has a role of setting prices for monopolies to prevent this activity. When the government sets the prices, monopolies desist from supplying low when demand is high to collect high revenues through high prices.
Furthermore, the government regulates prices to prevent barrier of entry to market caused by monopoly price strategies (Margaret Ray, 2015). Monopolies due to reduced unit costs have the ability to charge very low prices for their products. This is causes difficulty to sellers wanting to enter a monopoly market as they lack ability to charge low prices. New entrants incur very high start-up fixed costs, which results to them charging high for their products. The prices are higher than what existing monopolies charge with their low unit production costs. Customers therefore buy more products from the existing monopolies and not from the new monopolies. The new monopolies lack sales to raise revenues to cover their costs ending up with huge losses. They thus result to shutting down operations. The government should protect such harmful activities by regulating monopoly prices. When a maximum price is set, all monopolies new and existing get a uniform forum for pricing their products. They are able to sell in the market without harmful competition from the existing monopoly. They thus make sales revenues, which cover costs and prevent losses and as a result, they do not get out of market. Price regulation is very important in the growth of economies markets by protecting infant companies from unethical pricing strategies in competition.
Moreover, the government can regulate prices due to having ownership in the monopolies (McConnell, 2014). The government owns monopolies through buying more than half of the shares or sale of products. The government owned monopolies deal with products that are important to the citizens of the nation. Products such as postal services and utilities like water and electricity supply is by the government monopolies. The reason for government to supply these utilities is due to their high costs of operations and the need to protect citizens from oppression. Some utilities like water require equity in supply and thus the government takes part in the supply to ensure all citizens access water service. The government being the owner of these monopolies regulates the prices of commodities dealt with. Prices control ensures that all citizens afford the prices for utilities. When charged highly, the citizens find it unfair because not all are able to afford the products. These results to unfairness in the distribution of utilities and thus the government should regulate the prices for these monopolies.
In addition to that, the government regulates prices for monopolies to ensure that products are affordable to all citizens (Tyler Cowen, 2014). The government has a role of ensuring that citizens do not pay exaggerated prices for products. When products sell for high prices, the opportunity cost for citizens’ increases and they end up buying less commodities in the market. The government reduces prices for monopolies products to reduce opportunity cost for citizens and ensure that they do not spend a lot of income buying products. The government also regulates prices to prevent monopolies from earning exaggerated profits. Prices set by the government ensure that they do not make unnecessary profits from sales revenues, which is unethical.
How government regulates natural monopoly prices
The government to ensure that the prices for natural monopolies is controlled, various steps are used. The steps are used each according to the need price problem that the government wants to regulate. Economic planners develop price regulatory steps. They try to come up with a solution that benefits the market at large. Their main aim however is to ensure that monopolies do not exploit customers with high prices. The policies set usually aim at reducing the ability of monopolies to earn exaggerated incomes.
Steps such as setting price ceiling regulate monopoly prices (O’Sullivan, 2005). This refers to the government setting a maximum price for a product in the market. The law states that the product does not sell at a higher price than this maximum limit. This enables the customers to buy a product at affordable price, which is usually at the set maximum price or less. This limit is important as it ensures that the monopolies do not exploit their customers. The price limit is usually set at a point where the monopoly covers its costs from the price and earn reasonable profits.
Furthermore, the government can control prices through giving subsidies to the monopoly (Paul Krugman, 2015). Subsidies are grants to a company from the government to reduce the expenses they incur. The company as a result charges lower prices for their good compared to when the government did not grant subsidies. This is because the company does not need to charge very high prices to recover costs from sales. The result is that the company is able to sell products at affordable prices to their customers.
Moreover there is the policy of average cost pricing. This is putting a price limit that matches general costs incurred by a producing company (Sowell, 2014). The price set usually is not far from the unit costs incurred producing each product. This price is set after a bargain between the government and the monopoly to come up with an appropriate average price. The price is set at a point where unit production costs are recovered and reasonable profits made. Average prices ensure fairness to customers and the monopoly in terms of profit making and cost realisation.
In addition to that, the government can use the tax system to regulate prices. The government uses high taxes for monopolies charging high prices and low taxes for those with low prices (Tucker, 2016). This is like an incentive to the monopolies to charge low prices for their products. This policy is very beneficial because most monopolies with the aim of paying less tax, they charge low prices for their products. This policy benefits the consumers as they pay for products at prices that justify their utility. The company does not make exaggerated profits from exploiting customers with high prices. The government should ensure adherence to all policies by monopolies without failure.
Conclusion
Natural monopolies have the ability of exploiting their customers through prices. They are able to charge very high prices for their products without reducing sales due to competitors charging less. The government thus has a responsibility of protecting the consumers because market forces are not present to protect the customers. Monopolies too should be ethical in their activities to ensure that they consider the purchasing ability of customers when setting prices. Government policies for regulating monopoly prices should be considerate to ensure that the monopoly do not suffer losses trying to adhere to government policies (Williamson, 2013)
References
Arnold, R. A. (2015). Macroeconomics (12th ed.). South Western College.
Behravesh, N. (2014). Economics USA 8th edition. W.W.Norton and Company.
Burda, M. (July 25, 2017). Macroeconomics (7th ed.). Oxford University Press.
Flynn, S. M. (2011). Economics For Dummies (2nd ed.). For Dummies.
Jones, C. I. (2017). Macroeconomics (4th ed.). W.W. Norton & Company.
Lee, D. M. (2017). Principles of Macroeconomics (2nd ed.). W.W.Norton & Company.
Mankiw, G. (2017). Principles of Economics (8th ed.). South Western College Pub.
Margaret, D. A. (2015). Macroeconomics for AP (2nd ed.). Worth Publishers.
McConnell, C. R. (2014). Economics: Principles,Problems & Policies. McGraw-HIll Education.
MIller, R. L. (2017). Economics Today (19 ed.). Pearson.
O’Sullivan, A. (2005). Economics:Principles in Action. Prentice Hall.
Paul, R. W. (2015). Economics (4 ed.). Worth Publishers.
Sowell, T. (2014). Basic Economics (5 ed.). Basic Books.
Tucker, I. B. (2016). Macroeconomics for Today (9th ed.). South Western College.
Tyler, A. T. (2014). Modern Principles:Macroeconomics (3rd ed.). Worth Publisher.
Williamson, S. D. (2013). Macroeconomics (5th ed.). Pearson
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