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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

what the word federal mean
Kabba Reply
Meaning of "movement along curve?
Lizabeth Reply
There is movement along curve whenever the 'price' is affected
its mean price is positively response as demand change and price is negatively reaponse as supply changes
its mean when quantity demanded of commodity changes due to a change in its price ,keeping other factors constant, it is know as change in quantity demanded.
pleas wat the formula when calculating for equilibrium point
when there is increase in the price
when there is increase in demand, demand will decrease.
A movement along curve is a movement on the curve mainly caused by a change occured in both quantity demand and quantity supplied.
what is demand
Dennis Reply
unwilling to buy good quality at a particular price and a particular time
Demand is the willingness and ability to buy goods and services at different prices at a given time.
is production function different from psychological law of consumption?
Kshirodra Reply
why supply is not the same quantity supplied
emmanuel Reply
What is Elasticity?
I don't even understand
what is damand
Elasticity is an economic concept used to measure the change in the aggregate quantity demand for a goods or service in relation to price movements of that goods and service.
Demand is an economic principal referring of a consumers desire to purchase goods and service and willingness to pay a price for a specific goods or service.
supply is not the same as quantity supplied, because when economic refer to supply, they mean the relationship between a range of price an the quantity supplied those price -are relationship that can be illustrated with a supply curve or supply schedule
Is a science which study human behavior as a relationship between ends and scares means which have alternative uses
I dont think so
It is Economic growth and stability
How Economic recovery growth Planning
Mahmood Reply
Expatiate your question
Are bonds the same as liabilities?
Anderson Reply
Demend create it own supply how?
what is way ofrece thinking
what is the Economic way thinkig?
what is gasoline
Deepak Reply
how to know which products demand
in other words economic can be define as what?
Ojarigho Reply
what is the difference between economics activities and economics system
Joshua Reply
what is the difference between price elasticity of demand and income elasticity of demand
Ellen Reply
what is demand
Alpha Reply
What is demand
is a measure of responsiveness at which a consumer is willing and able to offer a particular product at a given period of time
what is consumer
chill Reply
what is economics?
Odei Reply

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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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