Government Intervention in Natural Monopoly -myassignmenthelp

Question: Discuss about theGovernment Intervention in Natural Monopoly for Demand. Answer: Introduction Out of the various market structures operating in the modern world, monopoly market earns utmost importance as it lays greater impact on the market price and quantity being supplied with having much power in driving the forces of demand and supply (Hancock, 2012). A monopolist is the single seller taking care of the entire supply in the specific market he is operating in and he has the exploitative power to restrict or change the quantity of supply in order to charge high price and capture much higher profit than normal economic profit. Natural monopoly is certain kind of monopoly that have only difference from the core monopoly market that is in terms of underlying fixed cost into the production or business process (Weisman, Sanders Moundigbaye, 2012). Natural monopoly operates mostly in public utility sectors that serves larger share of population and this evokes the concern of government in order to ascertain whether the social welfare motives are maintained or not (Hilmer, 2017) . This essay sheds light on the nature of the natural monopoly market with highlighting the factors that have implication on mass welfare (Hilmer, 2017). Further based on that, the importance of government intervention have been discussed along with the probable mechanism in terms of policies adopted by them in order to ensure the availability of goods and services and its accessibility by mass at optimal price without supply side issues arising in the market that may disrupt the economic stability (Hancock, 2012). Analysis: What is Natural Monopoly In specific business if the production operation and decisions are ruled by one sole producer then it is called monopoly production (Stiglitz Rosengard, 2015). Natural monopoly implies to the monopoly operation evolving naturally empowering the producer to not only operate solely but also drive out every possible other producers by charging much lower price for the goods than one can do under monopoly situation (Crozet, Nash Preston, 2012). Natural monopoly is existent mostly in market that provides service related to public utility sectors like construction of roads, extraction and supply of natural resources like natural gas, coal, iron ore and crude oil. These kind of operations require different or unique raw materials, technological support or other factors comparatively costlier requiring huge investment cost and production cost as well. Government allows existence of this kind of monopolies simply because of the resultant economic profitability as well as social benefits der ived by entire population. Natural monopoly does not necessarily means only one producer in the market. There can be other producers of the same goods and services as well but the driving factor that keeps natural monopolist one step ahead is the ability it has to incur higher fixed cost that many of his competitors cant and as a result the producer turns out to become sole supplier creating scope of being a natural monopolist. Natural Monopoly The ability of natural monopolist to charge such low price emanates from larger amount of consumers taking the service from him (Shephard, 2012). As the number of buyers or consumers rise the average total cost in form of high investments made to the business leading to operation fixed cost the production keeps falling. The greater start up cost inflicted in the process hinders the other entrants to the market that drives the monopolist toward natural monopoly (Katsoulacos, Genakos Houpis, 2015). A natural monopolist is the sole producer and supplier operating at large scale in specific market enjoying economies of scale which allows him to charge lower prices which is socially optimal and less than any regular monopolist (Baumol Blinder, 2015). Fig-1: Monopoly Market A regular monopolist produces the amount (QM) where marginal cost equals marginal revenue and charges PM which is pretty high and also the source of higher economic profit and higher producer surplus (Rader, 2014). The reason behind high price charged is the higher average total cost faced by the monopolist (Crozet, Nash Preston, 2012). Natural monopolist differs from this point as it produces the amount where marginal cost equalizes marginal benefit ensuring social optimality as reflected in the price (PSO) and quantity (QSO). Fig 2: Natural Monopoly Market From Fig2, its evident that price in natural monopoly market is much lower and incurs economic loss compared to the monopoly market (Minamihashi, 2012). Price is low due to the fact that natural monopolist produces at the point where ATC is lower and falling continuously which encourages higher production and ability to charge much lower price (Yan, Z. O. U. Chao, 2012). The monopoly market is driven by profit maximization motive and such economic loss is disincentive for the producer who already has captured larger market share (Baldwin, Cave Lodge, 2012). In reality, producer and supplier of natural resources like water, electricity natural gas happen to be natural monopolist encountering large production and market supply and catering service to huge consumer base that allows them to enjoy economies of scale (Hilmer, 2017). Why Government Needs To Intervene It is quite evident that natural monopolist becoming ultimate supplier of goods and services captures much market share and also earns popularity by providing services at low cost. This further confers them much power in order to distort the decision regarding supply to manipulate demand and price in his favor (Walras, 2013). For example if the natural monopolist who provides electricity in the market decides to charge higher price per unit of electricity by contracting energy supply then it would disrupt the market stability and affect equilibrium in the market leading to severe economic issues arising chain wise (Bolton Foxon, 2013). To prevent the natural monopolist from exercising the ultimate power he achieves in the market in form of charging higher market price or restricting supply, government comes to the scene to supervise as well as provide assistance to ensure social benefit and welfare (Shephard, 2012). To exploit the benefit of any economic activity on broader term soc ial benefit should be in parity with social cost. Sustenance of this additively ensure the social welfare which is necessary component for an economy to run at its operative efficiency as well as promoting equitable growth. For this per unit of production socially derived marginal benefit has to be equal with incurred marginal cost socially to stop the proceeding toward disequilibrium and market failure by creating externalities. As embodiment of social security provider, government should intervene in the planning and operation execution of the natural monopolist. Government Intervention Policies The most important form of policies that are undertaken by government can be implementing price controls. It consists of imposition of price floor and price ceilings that are so mechanized to deter the supplier from charging the market equilibrium price if found to be too low or high respectively (Hall Lieberman, 2012). When government finds the equilibrium market price to be too high from the general affordability and welfare point of view then it adopts the policies and implement laws that restricts the market price to reach up to its equilibrium level . In such cases, at the ceiling price, much of the buyers remain deprived of the services and excess demand exists (Fuss McFadden, 2014). Again when market price found to be to low hurting the producers being unable to cover the cost of production in the price obtained, then it imposes price floor allowing price not to fall below that. This situation induces more production but due to higher price than the equilibrium one, less con sumers now opt for the goods and services and as a result excess supply exists in the market (Hall Lieberman, 2012). In this case, if government imposes a price ceiling at PSO which is socially optimal, then the monopolist loses economic profit by the highlighted area (in fig2) which hinders his profit maximizing motive and demoralizes him. This can be counteracted by providing subsidy to the monopolist (Rader, 2014). The monopolist would prefer production at most to the point (QM) where marginal revenue is zero and wont like to produce beyond that. To make him operate at QSO, the marginal cost should have to be shifted down to MC1 so as the ATC. This negative cost acts like revenue to the monopolist firm and provided in form of subsidy by government (Nowotny, Smith Trebing, 2012). Real World Example Crude oil is one of the important natural resource having utmost national as well as international importance. The extraction of the resource, refining and supply in form of petroleum, diesel and other auxiliary products coming out of it create a huge production process (Fandel, 2012). This definitely requires lot of financial investment due to higher fixed cost required initially for the proceedings of the end supply (Shephard, 2012).. Now suppose an organization A is existent market producer in the crude oil market and have ability to incur the higher start up cost. As a result it would continue the production process and create large supply chain capturing huge market share as oil is the pivotal element used as fuel and industrial inputs in any nation (Joskow Wolfram, 2012). The company A gains much of market share and that is the reason it can provide oil at comparatively low cost than any small organization lacking this benefit can provide (Roach, 2013). Now suppose due to shor tage in the supply of the resources, if the producer is unable to maintain existing supply in the market then this would result in higher price in presence of higher demand (Hilmer, 2017). The price hike would have detrimental effect on the stock exchange market and create a chain wise dismal in the economic activities and market outcome. Intervention of government in form of imposing a price ceiling can save the national economy (Becker, 2013). The government has to provide subsidy simultaneously to the company so that they can continue charging low price even amidst presence of resource crisis. This way the policy mix of the government can let the economic activity be continued without any hindrance. Conclusion The importance of natural monopoly is huge since it provides good and services to huge population generating a need of supervision in order to check whether mass satisfaction is managed efficiently or not. The public goods like, roads, bridges, mobile networks, rail services and natural resources like oil, electricity these form the public utility sectors and any big suppliers existent in the market of any of these can turn out to be a natural monopolist if it has the ability to bear the higher fixed cost compared to other producers. This gives them the benefit of operating alone in the market driving out other producers who are simply unable to provide the services at low price emanating from the higher fixed cost of the business engaged that keeps falling in presence of high volume of consumers. The monopolist can distort the supply anytime if he decides to earn higher price and profits respectively that would hurt the economic stability. To ensure such situations never arise, gove rnment keeps close monitoring in their market operation. 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