Question

1. Identify one regulated, private natural monopoly from which your household buys services. How is the natural monopoly regulated?

2. How do consumers benefit from the government creating and regulating a natural monopoly in this case instead of just allowing competition? (What would happen if there was no monopoly?)

Answer 1

Public utilities, the companies that have traditionally provided water and electrical service across much of the United States, are leading examples of natural monopoly.

Regulation of natural monopolies can be done through either average price costing or marginal price costing.

- Average price costing:

It is the most common form of regulation.

Monopolists tend to produce less than the optimal quantity pushing the prices up. The government may use average cost pricing as a tool to regulate prices monopolists may charge. Average cost pricing forces monopolists to reduce price to where the firm's average total cost (ATC) intersects the market demand curve.
The effect on the market would be:

1.Increase production and decrease price.
2.Increase social welfare (efficient resource allocation).
3.Generate a normal profit for monopolist (Price = ATC)

- Marginal Price costing:

It is also known as efficient regulation, forces the monopolist to reduce the price of product to the point where the firm's MC curve meets the market demand curve. Thus Marginal-cost pricing is the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labour. This increases output and reduces price but causes the monopoly to incur losses as the price is below ATC. Thus it may require government subsidies.

Consumers benefit from the government creating and regulating a natural monopoly as the average cost of production for natural monopoly decreases as single firm produces greater and greater output and thus the consumers are charged less as compared to the situation where no natural monopoly is present. Thus it increases social welfare and it avoids any possiblity of price discrimination(in case of no Natural Goverment regulated monopoly).