Question

The two primary methods of regulating monopoly power are to a) increase competition or b) set the price equal to the competitive price. Explain in words why neither of these regulations are desirable if the monopoly is a natural monopoly. Please answer the question fully and in detail for a rating. Thank you.

Answer 1

1)According to the first method, competition can be increased to regulate a monopoly. this is not possible for a natural monopoly because if competition is increased and other firms are allowed to operate, they all must have economies of scale. this is because natural monopoly has economies of scale where large scale production decreases the per unit cost continuously. This gives natural monopoly an advantage over other firms. it does not face any competition because no other firm is likely to produce and sustain by charging the same price. Hence competition cannot be increased

2) price cannot be set equal to the marginal cost which is also called the competitive price. this is because average total cost is greater than marginal cost at every unit for a natural monopoly. If price is equal to marginal cost it will be less than average total cost and there will be economic losses. Natural monopoly or even a pure monopoly cannot sustain for long if there are economic losses for a long period. Therefore competitive price is not a good strategy for regulation of natural monopoly