Natural Monopoly of Market Structures

Question: Discuss about the Natural Monopoly of Market Structures. Answer: Introduction There are different types of market structures which presently prevail in different economies. The basic and theoretical markets are perfectly competitive, monopoly, monopolistic, monopsony, and others. These structures are differentiated by the presence of consumers and producers in the market for a certain good or service. In case of monopoly, the number of consumers is so huge that they have no power over the determination of the price. On the other hand, the monopoly market structure is characterized by a single seller of a good or service(Lavoie, 2013). A natural monopoly is characterized by a market where the market itself possesses the potential of advocating a monopoly and creates a barrier against any new seller from entering the market. The barriers can exist because of the markets price structure, cost, geographical location, technology, or any other reason. The purpose of the essay is to find out the reasons behind the government interventions in natural monopoly and gove rnments setting the price charged by natural monopolies at the level where the demand curve cuts the average total cost curve In a monopoly market there are many buyers whereas only one seller sells a certain good or service. The market structure presents a utopian situation. Due to the large number of buyers and only one seller the buyers are price takers while the seller is price maker. A monopoly situation occurs in the market due to many reasons. It can be artificially created; it can also occur naturally. Natural monopoly, in most of the cases exists due to the cost structure working as a barrier from entry by the other sellers. Unlike pure monopoly, in natural monopoly, the monopolist plays the minimal or no role in creating such a market structure(Lim, 2015). In pure monopoly, the only seller in the market creates such situations intentionally where no other seller can operate. On the other hand, in natural monopoly no such initiatives are taken by the monopolist, still the market possess some traits which work as barrier for those sellers who want to enter the market. There are various reasons why n atural monopoly exists. It can be caused by the existing economies of scale, very high amount of fixed cost, and relatively low variable costs. The economies of scale states that with the increase in production, the marginal cost of production will fall. This fall is of high magnitude. This makes entry of any new producer in the market so costly that there will be no scope for earning profit. A very high amount of fixed cost will discourage any seller from entering the market. The fixed cost is the cost incurred by the producer even if there is no production going on. Moreover, if it is accompanied with the low variable cost of production which changes as the production amount changes, the barrier becomes stronger. There are also cases where the government creates natural monopoly using policies with subsidy, taxes, and other tools as barriers. Such decisions are taken by the government to reduce the social cost and ensure efficient allocation of the resources. The Australian railway system is state wise divided. The railways of Australia were under the government for a long time. During privatization, the government gave some of its parts to the private companies. Different companies operate in different places. The whole system runs under the guidance of the government(Laurino, 2015). The government also ensures that no two companies operate at the same place as it will reduce revenue for both the companies. The number of people at a place is more or less constant. The cost of establishing a railway system is huge. Hence, creating a railway system that divides the total revenue between the two companies, while the cost doubles, will reduce social welfare. Here, production is cheaper when there is only one producer. This presents a huge potential for the monopolist to earn huge profit from operating in the market. And the situation will reduce consumer welfare as well as the social welfare. To counter this, the government has to intervene. The government works as a shield for the benefits of the consumers. The situation can be depicted as shown below. As the figure above shows, the natural monopolist has the potential of enjoying supernatural profit being at the point where his marginal revenue equals marginal cost of production. MC in the figure above represents the marginal cost curve, and the MR curve represents the marginal revenue curve(Stiglitz, 2015). A monopolist can sell the same commodity to different buyers at a different price. Hence, there are no one to one correspondence between price and output in monopoly. As a result, there is no demand curve in monopoly. The average revenue curve (AR) is thus considered as the demand curve. The monopolist charges the price Pm and delivers output Qm in order to maximize profit. At the same time the monopolist could opt for maximizing revenue. In that case the revenue maximizing condition would equal the producers average revenue and average cost. The producer could offer output of Qr at price level Pr. From the figure, it can be seen that Pm is greater than Pr, whereas, Qr is grea ter than Qm. Hence, from the above situation it can be observed that due to the difference in the market structure the consumer pays more for fewer goods in monopoly(Simon, 2015). The government intervention in the case of natural monopoly is thus needed to make the market fair for the consumer as there are no other ways for the consumer or even the society to get any benefit in the natural monopoly structure. In the case where the average cost curve or average total cost curve is intersected by the average revenue curve, the consumers get more quantity at lower prices. This average revenue curve works as the demand curve for a monopolist. In terms of benefit, the consumer gets the maximum amount of quantity at a price which is much lower than the monopoly price. The consumer surplus remains unaffected here. The producer earns normal profit. There is no cost for the society. The social welfare is the maximum. In case of the natural monopoly, the producers benefit is that he gets to maximize his profit and earns a supernormal profit. The consumers get to pay more prices and get fewer amount of output. This reduces the consumer surplus. The producer surplus may increase from the previous situation. But in the whole process, a certain portion of the welfare is not acquired by any of the market agents. This portion is considered as the social cost of monopoly. This reduces the economys efficie ncy. Hence, in terms of benefits, only the producer gets benefited here as the consumer and the society loses their respective benefits. In terms of cost, the natural monopoly costs to the consumer and the society. The scarce resources are used by the producer to get less output at higher price. This reduces the economys efficiency level. The burden of this cost is not shared by the monopolist. If the government interferes in this situation and creates a policy which states that the price level has to be where the demand curve or the average total cost curve intersects with the average revenue curve, it will work as a price ceiling(Scitovsky, 2013). The monopolist cannot charge the price beyond this price ceiling. This reduces the cost of the consumer and the society, whereas, the producers cost of production increases as he is producing more output. The market structure was supposed to decrease efficiency in the natural monopoly scenario. The government setting the price where the average total cost and the average revenue is equal, introduces the market to a different market structure altogether. This new market structure works as revenue maximizing one, just like in a perfectly competitive market. The government changes the market structure for the benefit of the consumers and the society. This market structure will ensure that there is no dead weight loss. The market being a natural monopoly, presents no scope for the competitors to enter the market, this makes the single producer in the market the price maker. He can make any price he wants. The government setting the price level at revenue maximizing output will balance the market structure and make it more like revenue maximising structure. The dead weight loss which could affect the market from extra cost and reduced by the government intervention can be shown in the figu re below. In the figure above, the red zone represents the dead weight loss which might appear in the society due to choosing the market structure of natural monopoly. On the other hand, if the government ensures that the producer is producing at the point where the average revenue and average total cost curve intersects each other, the dead weight loss becomes zero. In other words, if the market structure changes to that of a perfectly competitive market due to government intervention, the dead weight loss zone disappears(Redmond, 2013). In the given example of Australian railways, due to privatization, some of the rail routes are under the private companies. No two companies operate at the same place, which creates the situation of the natural monopoly. Now if any of the company starts to increase the price of the tickets, the company can increase its profits. But the railway system was created by the government in order to provide benefits to the consumers(Schubert, 2013). Thus, the government intervenes in the price making system and sets the price level at the output level where the average revenue is equal to the average total cost. This benefits the consumers and the society as a whole. The cost incurred by the society becomes zero and the cost incurred by the producer becomes equal to its average revenue, giving the producer the chance of earning normal profit. Conclusion In conclusion it can be said that the government intervention in the cases of natural monopolies is thus targeted at reducing the social cost or the dead weight loss and help the consumers to afford a good or service. The natural monopoly situation offers a price level which is much higher than the price level in revenue maximizing situation where the government might set the price level to give the consumers a fair market scenario. The Australian government follows the same procedure in order to reduce the dead weight loss and help the consumers by fixing the price at the output level where the demand and the average revenue is equal. If this government intervention was absent from the Australian railway systems pricing strategy, then the profit maximizing price and quantity combination might have led the market to a failure due to inefficient resource allocation by the monopolists. This benefits the society and the consumers. Bibliography Laurino, A. R. (2015). The economic regulation of railway networks: A worldwide survey. Transportation Research Part A: Policy and Practice. Lavoie, M. (2013). Teaching post-Keynesian economics in a mainstream department. Lim, C. S. (2015). 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