PRICE REGULATED

NATURAL MONOPOLY
Presented by :- Sagarika Upadhyay
M.A. (Economics)
1st Semester
 WHAT IS
MONOPOLY??
MONOPOLY

A FIRM IS A MONOPOLY IF...

⚫IT IS THE ONLY SELLER OF ITS PRODUCT,

⚫ITS PRODUCT DOES NOT HAVE CLOSE
SUBSTITUTES.
Why Monopolies arise??

⚫ The fundamental cause of monopoly is the existence of barriers to entry.

⚫ Barriers to entry have three sources: Ownership of a key resource.

⚫ The government gives a firm the exclusive right to produce some good.

⚫Costs of production make one producer more efficient than a large number
of producers (Natural Monopoly)
Although exclusive ownership of a key resource is a potential
source of monopoly, in practice monopolies rarely arise for this
reason.

Example: Diamond
Government-Created Monopolies

⚫ Governments may restrict entry by giving one firm the

exclusive right to sell a particular goods in certain markets.

Example: Patent and copyright laws are two important examples

of how governments create monopoly to serve the public interest.
Natural Monopolies

 An industry is a natural monopoly when one firm can supply a

good or service to an entire market at a lower cost than could
two or more firms.

 In other words, natural monopoly is an industry in which

economies of scale are so important so that only one firm can
survive.

Example: delivery of electricity, phone service, tap water, etc.

Natural Monopolies
 A natural monopoly arises when there
are economies of scale over the relevant
range of output

cost

Average
total output

Quantity of output
DEMAND CURVES OF COMPETITIVE AND MONOPOLY
FIRMS
(a) Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve

Price Price

Quantity of output Quantity of output

DEMAND & MARGINAL REVENUE CURVES FOR A MONOPOLY
Price  Note that P=AR>MR at
$ 12 all quantities.
11
10
9
8
7
6
5
4
3
2
1
0
-1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Quantity of Water
-2
-3
-4
-5
-6
Types Of Natural Monopoly

Unregulated natural monopoly

Regulated natural monopoly

 Unregulated Natural Monopoly
 An unregulated natural monopoly would attempt to
maximize profits by producing the quantity of output
where marginal revenue equals marginal cost.
(MC=MR)
WHAT ARE CONSEQUENCES OF
UNREGULATED NATURAL MONOPOLY?
 Exploitation to customers

 Excessive profitability strengthen the monopoly power

 Inequitable distribution of resources

 Operational inefficiency, etc…

If so, How to curve????

Optimal Quantity

The optimal quantity of output occurs where price equals

marginal cost. (P=MC)

Thus, marginal social benefit equals marginal social cost.

Deadweight Loss

Producing the profit-maximizing output causes a deadweight loss.

The deadweight loss is equal to the area between the demand

curve and the marginal cost curve for the amount of
underproduction.

Deadweight loss: The costs to society created by market inefficiency due to inefficient allocation of resources. Price
ceilings, price floors, and taxation are all said to create deadweight losses. Deadweight loss occurs when supply and
demand are not in equilibrium
The solution is:
Regulating Natural Monopoly
If a natural monopoly is regulated to produce the optimal quantity
of output, the firm will suffer an economic loss.

To keep the monopoly firm to survive would require a government

subsidy to the firm to eliminate the economic loss.
Subsidy to Achieve Optimal Quantity

GOVERNMENT
SUBSIDY TO FIRM

Regulated price
 If government is not able to
provide the subsidy, What
could be the way out to control
the natural monopoly???
Zero Economic Profit/ Compromise output

To avoid the need for a subsidy, natural monopolies are often
regulated to earn zero economic profit (a normal rate of return).

But, this leads the following problems:

1. The natural monopoly lacks incentives to control costs. (price may

go up as cost)
2. The regulators may not be able to obtain accurate information.
Role of Government

 To overcome the monopoly power or the inefficiency of monopoly

firm or the inefficient allocation of resources, government can play
a significant role to balance the social benefits and the costs
through subsidy to the firm or determining the zero economic
profit. (Profit constraints – normal rate of return, price ceiling, etc.