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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

how does consumer make profit
Clifford Reply
Compare and contract the function of commercial bank and the central bank of Nigeria
Akwi Reply
what do think is the difference between overhead costs and prime cost
what is economics
Mohamed Reply
what is economics
Mohamed Reply
what is the basic economic problem
John Reply
what economics is all about?
Nomuhle Reply
what is a new paradigm shift
Austen Reply
Paradigm shift it is the reconcilliation of fedural goods in production
factors that affecting economic system
Bemen Reply
what is microeconomics
Nkanyiso Reply
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what does crux mean
what is demand
Jervis Reply
what are the factors of demand
What is money and banking
Dorcas Reply
which one of the bank do product money
central bank
no .... all bank its self...
commercial banking
different types of products banking are .... 1 bills of exchange, 2 leasing, 3 project finance and so on
Demand and supply
money can be defined as a medium of exchange
how third party insurance premium is calculated?
Eshetu Reply
why scarcity is a problem in economics.
don't worry about it, it's everywhere b/c no resources are full off in the world, b/c geometric increase of population growth.
price elasticity of demand is a percentage change in quantity demanded/percentage change in price.
Fadiga Reply
what is the formula for elasticity
Favy Reply
please be specific. Is it elasticity of demand or supply
we do not have a specific formulae for elasticity but we do have formulae for the types of elasticity and these are the types.Namely price elasticity of demand,Income elasticity of demand and cross elasticity of demand. please be a specific with your question.
sorry elasticity of Demand
The elasticity of demand is the change in demand due to the change in one or more of the variable factors that it depends on. ... The responsiveness of the quantity demanded to the change in income is called Income elasticity of demand while that to the price is called Price elasticity of demand.
price-elasticity-demand-formula Price elasticity of demand = % change in Q.D. / % change in Price

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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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