Why Is It Important for the Government to Regulate Natural Monopolies?
Why is it important for the government to regulate natural monopolies?
A natural monopoly arises where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual and potential competitors. This tends to be the case in industries where capital costs predominate, creating economies of scale that are large in relation to the size of the market, and hence high barriers to entry; examples include public utilities such as water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines); therefore, it is unlikely that a potential competitor would be willing to make the capital investment needed to even enter the monopolist's market. Gosport Ferry is an example of a natural monopoly.
In these cases, economists have argued that regulation may be appropriate. Government regulation can take many forms, but all involve putting limits on what a business (or consumer) can do. Certain activities, prices, or products become illegal and others become mandatory. The ideal form of regulation for a monopoly would be to force it to set its price equal to its marginal cost. Forced to price as if it were a price taker, the monopoly should find it profitable to increase output to the economically efficient level. However overheads may increase and if the price is fixed by the government then the businesses profit margins will decrease and then the standard of the service/good may fall.
In some cases, monopolies are essential in order to lower cost and save space. For instance, water and electrical companies have natural monopolies because it would be too expensive for businesses to build several pipelines or power lines. Also, some monopolies prevent the destruction of the environment, since multiple competing electrical companies would have to destroy more land in order to have multiple power lines owned by separate companies. Therefore it
A natural monopoly arises where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual and potential competitors. This tends to be the case in industries where capital costs predominate, creating economies of scale that are large in relation to the size of the market, and hence high barriers to entry; examples include public utilities such as water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines); therefore, it is unlikely that a potential competitor would be willing to make the capital investment needed to even enter the monopolist's market. Gosport Ferry is an example of a natural monopoly.
In these cases, economists have argued that regulation may be appropriate. Government regulation can take many forms, but all involve putting limits on what a business (or consumer) can do. Certain activities, prices, or products become illegal and others become mandatory. The ideal form of regulation for a monopoly would be to force it to set its price equal to its marginal cost. Forced to price as if it were a price taker, the monopoly should find it profitable to increase output to the economically efficient level. However overheads may increase and if the price is fixed by the government then the businesses profit margins will decrease and then the standard of the service/good may fall.
In some cases, monopolies are essential in order to lower cost and save space. For instance, water and electrical companies have natural monopolies because it would be too expensive for businesses to build several pipelines or power lines. Also, some monopolies prevent the destruction of the environment, since multiple competing electrical companies would have to destroy more land in order to have multiple power lines owned by separate companies. Therefore it