Question

Explain why the government might not want to stimulate competition in a market with a “natural” monopoly. Give and explain one alternative policy that would increase total surplus in such a market.

Answer 1

Meaning of a monopoly and why the government may permit it.

A monopoly is a market type wherein there is no competition in the market place, and only one single producer exists. He then has the authority of deciding the quantity of goods to be manufactured, the quality and the price of the same. Usually governments do not want monopolies to exist because they control pricing and have an unfair advantage of earning abnormal profit margins for themselves. However, one exception to this type of markets is that of natural monopolies.

A natural monopoly is one which comes into existence primarily because of extremely high restrictions or criteria which may be required for business owners to enter the market type, This may include the likes of industries such as water, electricity etc, which the government must ensure takes place at a low cost to the producer and the end consumer as well.

The government may permit such economies to exist, because of the fact that they produce goods at an economy of scale which is at the minimum possible cost. Increasing the competition would mean that firms would come in and increase the cost of production as well as the final prices for the consumers would also increase.

For example, the existing market for public utilities such as water or electricity have a single player in the market that produces the good at the least possible price. Now if you increase competition in the market by allowing others to enter, they would spend on marketing their product or their cost of operations may be higher than the existing monopoly. They would then increase the prices and due to increased competition, the market would see players offering the existing services or products at a higher rate to the end consumer which for a critical market type like electricity or power is not recommended.

Thus, we can conclude that natural monopolies exist due to the fact that the per unit cost of production is low and there are higher trade barriers or restrictions and requirements which do not permit others to enter this market place.

Alternative Policy: -

If the government wants to increase the surplus in such a condition the incentive of profits must be there for the business owners such that the effects of competition can be achieved without the existence of a formal market type.

The effects of a competitive market are that consumers get surplus goods as production increases and reaches everyone in the market type. This can be achieved by allowing the producer in the natural monopoly to sell his products or services at a percentage price above he costs. Then, the incentive to produce more increases as the company makes reasonable profits for its owners.

The purpose of expanding and maintaining a surplus can be achieved if the same policy is largely applied.

Please feel free to ask your doubts in the comments section.