Question

Many electrical and gas utility companies are monopolies because of

	A.	patent restrictions.
	B.	their inability to earn profits.
	C.	the absence of economies of scale in that industry.
	D.	government regulations that create barriers for new firms to enter the market.

Answer 1

Many electrical and gas utility companies are monopolies because

D. Government regulations that create barriers for new firms that enter the market.

It is a case of ‘natural monopoly’. A situation where the services like electricity, gas, water supply and so on are required by the public in general and hence the government undertakes the employment to provide these utility services since they have to be accessible to all—the rich who can afford for them and the poor who cannot afford them yet will need them as they are their basic living facilities.   They are provided on the welfare basis on not on the profit basis which would be the motive of the average private firm.

A natural monopoly is a market situation where there is only one firm providing a product or a service at very low costs of production. The firm may be in possession of a large amount of the required resources and will be able to produce the commodity easily, thus enjoying economies of large scale production –very low per unit costs, so low that it would be barrier by itself for other new firms to enter the market since they may not be able to produce the commodity or service at such low costs.

This is usually the case with essential services like gas, power supply, water supply, dams, railways and so on. The initial set up costs are very high requiring huge capital expenditure, also in some cases the gestation period ( time between investment and the commencement of production ) too is huge long hence the private sector which will not be willing to ‘waste time’ awaiting the required returns since it will , in general, not posses as many resources that are available with the public authorities. In most of these cases the initial fixed costs are too high and become a bigger proportion of the total cost structure than the variable costs. As the project work commences , the average fixed costs –fixed cost proportion per unit produced decreases and this will enable the enterprise to gain from very low average costs per unit –referred to as economies of scale.

For instance , the costs of setting up the power plant may be too high initially , but as then plant commences production the installation costs and costs of capital investment incurred will be so low a proportion to the total costs incurred that the public enterprise will be able to supply power at very low and affordable rates , especially to the poorer segment of the population. This is especially found in developing countries where the majority of the population may be either below the poverty line or just above it, a major part of the work force would be engaged in farming especially subsistence farming and hence providing electricity to such a segment is a basic responsibility of the governments.

Such services are also generally subsidised and hence the costs of production are partly or to a greater extent met by subsidies from the government. In case of losses the extent of losses is also met by subsidies or grants by governments.

There is no ‘economic reasoning’ in private sector wanting to enter such areas since ‘governmental finances ‘ are needed to keep the prices very low so that they meet the social objective of ‘providing basic essential needs to all’.

A. Patent restrictions.

    Patents are granted by government for an inventor of a newer appliance, device, technology, process and so on. These are granted for a certain period of time and are mainly a gesture to boost research and scientific developments. The aim is to cover any risks involved in the process of research. Public utilities cannot be given patent rights—they are essential goods that are required by all in the society. If they are patented then the private individual will want to sell the patents for profits and thus negate the social welfare objective of the government.

B. Their inability to earn profits.

    In the long run these services enjoy very low costs of production and hence earn normal or super normal profits however, in certain cases there are losses also since these services are supplied at very low and subsidised prices in order to be made available to all—especially the under privileged who will need them yet may not be able to afford them. Hence even though they run into losses these enterprises continue their production process. This fear of huge losses may naturally deter other private sector firms from entering this market whose primary objective is to earn profits.

C. The absence of economies of scale in that industry.

   This is not true since such enterprises enjoy economies of scale. Especially in the long run. The average costs will generally be lower for long periods of time implying that the economies of scale operate due to large scale production. These may be in the form of technical , due to huge investment in capital equipment , financial , due to large amount of resources available with the government to finance these projects. Hence even in case of losses these enterprises are able to survive with the funds from the public authorities.