Economic Interaction Between Natural Monopoly And Regions Essay

Question:

Discuss about the Economic Interaction Between Natural Monopoly and Regions.

Answer:

Introduction

This study is helpful to understand the reason why government of Australia want to set the price charged by the natural monopolies at the level where demand curve intersects the average total cost. Firstly, this study has tried to provide the concept of natural monopolies. In this study, the example of natural monopolies of Australia has also mentioned. On the other hand, this study is benefitted to understand the benefits, cost structures and the market structure of the natural monopoly. The types of monopoly and their nature of differences would be mentioned in this context. In this context, it can be mentioned that within a market, the price of a product under natural monopoly market would be cheaper compared to the two or more equivalent producers. This study would describe the government of Australia’s decision regarding the role of natural monopoly in the market of Australia.

According to Carvalho & Marques (2014), it can be mentioned that natural monopoly is a situation of monopoly, where the higher infrastructural cost and the barriers to entry of an industry is connected with the size of the market. As a result, the largest suppliers get the advantage and have the competitive advantage over the other competitors in the market. In this purpose, Crew & Kleindorfer (2012) mentioned that where the capital costs are predominating and have the economies of scale compared in the connection with large size of the market. Australian electricity providers are the good example of natural monopolists.

In the words of Crozet, Nash, & Preston (2012), it can be mentioned that there are two types of costs, which are essential for the natural monopolies such as marginal cost and the fixed cost. The marginal cost is helpful to serve more consumers. On the contrary, Haucap & Klein (2012) argued that natural monopoly does not exist. In this connection, it can be stated that marginal costs decreases with the economies of scale. The average costs of the organisational products and services would also decrease. Moreover, it can be mentioned that the natural monopolies has several cost structures. Haucap & Klein (2012) opined that the fixed cost in case of natural monopoly is comparatively higher and it is not depending upon the output. However, the marginal cost of production is constant and comparatively lower.

This study has provided the concept why government wants to impose the price of products as per the decision of natural monopolists. According to Makwe, Akinwale & Atoyebi (2012), it can be mentioned that government wants to regulate natural monopolies in order to provide protection to the interests of the customers. More specifically, it can be added that government can effectively prevent the growth of the monopoly power. Firstly, government can reduce the excessive prices of the products. If the government of Australia does not implement the natural monopoly in the market then the producers may set higher prices of the products. As a result, the consumers may suffer from the problem of allocative inefficiency. Hence, it can be mentioned that consumer welfare level will be decreased. In this context, Haucap & Klein (2012) opined that due to higher economies of scale, the government of Australia requires to encourage the competition in the market. Therefore, the new entrants create the potential loss of efficiency. In is necessary to regulate the organisations by preventing the excessive use of monopoly power. Minimum efficient scale is required to be the lowest level of outcome. In this position, the scale of economies can be effectively exploited.

Cost structure

In case of natural monopoly, the average total cost is continuously falling due to the presence of economies of scale. In this situation, it can be noticed that marginal cost of products is below the average cost of production.

The above figure depicted that the long run average cost under natural monopoly has been falling constantly. The reason can be described as the economies of scale are formulated in the market, therefore, average cost continuously fall. On the other hand, it can be mentioned that in order to maximise the profitability of a firm, the natural monopolist could charge Q, and therefore, the firms can earn super normal profits. On the contrary, Minamihashi (2012) criticised that in case of losses under natural monopolies, the government can provide subsidy to the organisations.

Advantages of natural monopoly

The advantages of natural monopolies can be discussed in the following manner:

Average cost pricing

As per the statement of Nizovtseva (2014), it can be mentioned that average cost pricing can reduces the pricing flexibility of the organisation and assures that the monopolies cannot capture above the margins.

Price ceiling

As opined by Crew & Kleindorfer (2012), natural monopoly may be formulated through the enforcement of higher charging potential prices. With the help of the strategy of price ceiling, it can be mentioned that the definite products cannot be sold above the specific prices.


Rate of return regulations

This is equivalent to the average cost pricing. In this connection, it can be mentioned that the percentage of net profitability could be brought in an organisation requires to set under the government specified percentage. This will in turn assures the compliance along with the governmental regulatory approaches.

Tax or subsidy

In the point of Stiglitz & Rosengard (2015), it can be mentioned that the governmental bodies can improve natural monopoly by maximising the taxes on larger producers. Precisely, the government allows financial support through the subsidies to the new entrants, which in turn assures the competitive environment, is highly equitable.

Market structure

As opined by Minamihashi (2012), it can be mentioned that when the economies of scale under monopoly has been increasing continuously based on the size of the firm, the natural monopolist firm would be able to provide the entire market demand in terms of lower cost compared to the two or more firms. On the other hand, it can be mentioned that there are two types of natural monopoly in the market such as strong monopoly and weak monopoly. When strong natural monopoly reflects the decreasing average costs, on the other hand, the weak natural monopoly firms reflect the increasing average costs. If the costs under natural monopoly are sub additive, the existing market would prefer a market which consist only one firm compared to the same output producing multiple firms. As a result, Haucap & Klein (2012) mentioned that under the weak monopoly market structure, the regulatory authorities bar entry into this type of market, the natural monopolists can control the prices of the products. In addition, it can be stated that strong natural monopoly exists if the long run average cost curve of a single firm is decreasing up to the point where long run average cost curve intersects the overall market demand curve.

The market structure can be illustrated by figure 2. With the help of the above figure, it can be observed that one firm would be able to provide goods and services to the consumers in the market comparatively lower rate compare to the two or more firms. For example, it can be mentioned that if Australian market consist of four firms and each of the firm produced at the optimal level, then it can be opined that marginal revenue is equivalent to the marginal costs. Therefore, it can be stated that the market price would be determined by the total market demand curve. This would in turn add up the price of the product up to the level of Px. On the other hand, from the above figure it can be noticed that at the point b, the market is restructured among the four firms, despite of one natural monopoly firm, each firm would be able to produce at a smaller scale. Moreover, it can be mentioned that entire produced output would be unchanged, however, the average unit costs is higher at point b. Hence, it can be inferred that the market helps to a single producer to formulate the entire market demand at cheaper rate compare to the more than one equal producer.

Government’s decision

In the words of Makwe, Akinwale & Atoyebi (2012), it can be mentioned that under natural monopoly, the long run average cost curve declines constantly over a greater output range. The government of Australia requires to implement the strategies of natural monopoly within the market. In this purpose, it can be mentioned that the people of that country would be benefitted as a large business can supply products to the consumers at a lower price compare to the more than one seller. Therefore, consumer’s satisfaction level would be increased. In addition, it can be mentioned that in case of natural monopoly, only one firm exist in the market. Therefore, Stiglitz & Rosengard (2015) added that there would be no competition within the market. Therefore, it can be inferred that the cost and the price of the products would not be increased. This would in turn helpful to increase the welfare level of the consumers. In this point, it can be concluded the government of Australia requires to formulate natural monopoly system within the market.

In order to discuss the importance of natural monopoly and why government requires to implement natural monopoly system within the market, it is necessary to identify the practical example of natural monopoly. Minamihashi (2012) cited that Australian electricity producer is an appropriate example. The behaviour of the electricity producer is seemed to be inelastic. This refers that the electricity producers would increase the price of the product, however, the demand would not be changed. Therefore, from the point of the electricity producers, they would be able to maximise their profitability statement due to the absence of competition. On the other hand, in short run it can be mentioned that the profitability statement of the organisation would be increased. On the contrary, Nizovtseva (2014) it can be argued that if the organisation charged higher price due to inelastic demand of the products, government do not require to formulate the practice of natural monopoly within the country. Apart from this, it can be recommended that in this situation government requires to allow to enter other suppliers to enter into the market. Therefore, the price of the products would be decreased by entering more suppliers into the market. Although the natural monopolists would not able to earn super normal profit in the short run, would earn normal profit.

Conclusion

This study has highlighted the market structure of natural monopoly. In this connection, it can be observed that the cost would be sub additive in the natural monopoly market compared to the two or more equivalent firms. This study is also helpful to identify the structure of average cost, marginal cost and the fixed cost of the long run as well as short run. On the other hand, this study is helpful to discuss the short run and the long run profitability statement under natural monopoly. Furthermore, in this study, the types of natural monopoly has described such as the strong natural monopoly as well as the weak natural monopoly. Lastly, this study has provided the government’s decision regarding the use of natural monopoly.

References

Carvalho, P., & Marques, R. C. (2014). Computing economies of vertical integration, economies of scope and economies of scale using partial frontier nonparametric methods. European Journal of Operational Research , 292-307.

Crew, M. A., & Kleindorfer, P. R. (2012). Managing change in the postal and delivery industries. Springer Science & Business Media.

Crozet, Y., Nash, C., & Preston, J. (2012). Beyond the quiet life of a natural monopoly: Regulatory challenges ahead for Europe’s rail sector. CERRE, Brussels.

Haucap, J., & Klein, G. J. (2012). How regulation affects network and service quality in related markets. Economics Letters. , 521-524.

Makwe, J. N., Akinwale, Y. O., & Atoyebi, M. K. (2012). An economic assessment of the reform of Nigerian electricity market. . Energy and Power. , 24-32.

Minamihashi, N. Natural monopoly and distorted competition: evidence from unbundling fiber-optic networks. 2012.

Nizovtseva, I. (2014). Generalization index of the economic interaction effectiveness between the natural monopoly and regions in case of multiple simultaneous projects. . Applied Mathematical Sciences. , 1223-1230.

Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.

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