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By the end of this section, you will be able to:

  • Evaluate the appropriate competition policy for a natural monopoly
  • Interpret a graph of regulatory choices
  • Contrast cost-plus and price cap regulation

Most true monopolies today in the U.S. are regulated, natural monopolies. A natural monopoly poses a difficult challenge for competition policy, because the structure of costs and demand seems to make competition unlikely or costly. A natural monopoly    arises when average costs are declining over the range of production that satisfies market demand. This typically happens when fixed costs are large relative to variable costs. As a result, one firm is able to supply the total quantity demanded in the market at lower cost than two or more firms—so splitting up the natural monopoly would raise the average cost of production and force customers to pay more.

Public utilities, the companies that have traditionally provided water and electrical service across much of the United States, are leading examples of natural monopoly. It would make little sense to argue that a local water company should be broken up into several competing companies, each with its own separate set of pipes and water supplies. Installing four or five identical sets of pipes under a city, one for each water company, so that each household could choose its own water provider, would be terribly costly. The same argument applies to the idea of having many competing companies for delivering electricity to homes, each with its own set of wires. Before the advent of wireless phones, the argument also applied to the idea of many different phone companies, each with its own set of phone wires running through the neighborhood.

The choices in regulating a natural monopoly

So what then is the appropriate competition policy for a natural monopoly? [link] illustrates the case of natural monopoly, with a market demand curve that cuts through the downward-sloping portion of the average cost curve . Points A, B, C, and F illustrate four of the main choices for regulation. [link] outlines the regulatory choices for dealing with a natural monopoly.

Regulatory choices in dealing with natural monopoly

The graph represents a natural monopoly. The graph shows four points that represent the main choices for regulation, a downward-sloping average cost curve, and a downward-sloping market demand curve.
A natural monopoly will maximize profits by producing at the quantity where marginal revenue (MR) equals marginal costs (MC) and by then looking to the market demand curve to see what price to charge for this quantity. This monopoly will produce at point A, with a quantity of 4 and a price of 9.3. If antitrust regulators split this company exactly in half, then each half would produce at point B, with average costs of 9.75 and output of 2. The regulators might require the firm to produce where marginal cost crosses the market demand curve at point C. However, if the firm is required to produce at a quantity of 8 and sell at a price of 3.5, the firm will suffer from losses. The most likely choice is point F, where the firm is required to produce a quantity of 6 and charge a price of 6.5.
(*Total Revenue is given by multiplying price and quantity. However, some of the price values in this table have been rounded for ease of presentation.)
Regulatory choices in dealing with natural monopoly
Quantity Price Total Revenue * Marginal Revenue Total Cost Marginal Cost Average Cost
1 14.7 14.7 - 11.0 - 11.00
2 12.4 24.7 10.0 19.5 8.5 9.75
3 10.6 31.7 7.0 25.5 6.0 8.50
4 9.3 37.2 5.5 31.0 5.5 7.75
5 8.0 40.0 2.8 35.0 4.0 7.00
6 6.5 39.0 –1.0 39.0 4.0 6.50
7 5.0 35.0 –4.0 42.0 3.0 6.00
8 3.5 28.0 –7.0 45.5 3.5 5.70
9 2.0 18.0 –10.0 49.5 4.0 5.5

Questions & Answers

why should a firm close down when it's unable to pay it's variable cost?
what is oligopolistic competitive market?
exchange of goods and services between countries is call
Hosea Reply
what is constant opportunity cost
Tiffany Reply
Constant opportunity cost means the value of sacrifice remains constant in every step.
Gross Domestic Product GDP
Yusuf Reply
what is g d p
Jayapal Reply
gross daily performance
How best can a poor country respond to an economic crisis , what does it have to sacrifice.
Bah Reply
they should pay tax as progressive system and should make sacrifice for taxation of their income and land etc
how have the nations tries to solve the problem of scarcity in their economies?
Amani Reply
total concentration on to reduce the per unit cost of commodity by technically or whatever
explain what will happen to producer of green coconut now that we have to lockdown in the kingdom of tonga
Tuha Reply
the demand for coconut will decrease and supply increases which result in the decrease in the price of coconut and the coconut will be more elastic
tonga is producing more long run economic good explain the meaning of the statement and its implication on the tonga economy
Tuha Reply
Demand is the various quantities of goods and services that consumer(s)are willing and able to purchase at a price within a time
Muhammad Reply
What is demand
Mc Reply
demand relates with the need of people for their satisfaction.
Distinguish between cross elasticity and income elasticity of demand
Ruth Reply
Distinguish between cross elasticity and income elasticity of demand
if change in the demand of the commodity with respect to change in demand of the substitute or other product called cross elasticity
and. if change in the demand of the commodity due to change in the income . called income elasticity
Cross elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to a small change in price of another commodity whiles Income elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to a small change in income of it's consumers
but these are book wordings
income elasticity of demand shows how quantity demanded changes due to changes in income on the other hand cross elasticity refers to how the quantity demanded of a particular good alers given a change in the price of another good.
what is the competitive demand
Adiza Reply
Competitive demand are those commodity dat are competitive in nature e.g the close up and my my toothpaste the increase in price of close up may bring abt decrease in demand of it and it will serve as increase in purchase of my my
With regards to coal shortage and manicipal debts the what form of intervention do you think Eskom can put in place.
kedibone Reply
economic growth of Bhutan
Nima Reply
please, explain all the mathematics terms used in economics
The answer is: little more than high school algebra and graphs.

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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