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Ch 12 – Natural Monopoly

Ch 12 – Natural Monopoly. Antitrust vs. Regulation. Under ideal conditions, the market mechanism provides optimal outcomes: All producers must be perfect competitors. People must have full information about tastes, costs, and prices. All costs and benefits must be reflected in market prices.

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Ch 12 – Natural Monopoly

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  1. Ch 12 – Natural Monopoly

  2. Antitrust vs. Regulation • Under ideal conditions, the market mechanism provides optimal outcomes: • All producers must be perfect competitors. • People must have full information about tastes, costs, and prices. • All costs and benefits must be reflected in market prices. • Pervasive economies of scale must be absent.

  3. Antitrust vs. Regulation • These ideal conditions are rarely, if ever, attained, leading to market failure. • Market failure - An imperfection in the market mechanism that prevents optimal outcomes.

  4. Behavioral Focus • Antitrust is government intervention to alter market structure or prevent abuse of market power. • Regulation is government intervention to alter the behavior of firms, for example, in pricing, output, or advertising.

  5. Natural Monopoly • A natural monopoly is desirable because it can achieve economies of scale. • It is likely that consumers will not benefit from the resulting cost savings. • Natural monopoly – An industry in which one firm can achieve economies of scale over the entire range of market supply.

  6. Declining ATC • The distinctive characteristic of a natural monopoly is its downward-sloping average total cost (ATC) curve. • The marginal cost (MC) curve lies below the ATC curve at all rates of output.

  7. Declining ATC • The economies of scale offered by a natural monopoly imply that no other market structure can supply the good as cheaply. • Economies of scale - Reductions in minimum average costs that come about through increases in the size (scale) of plant and equipment.

  8. Unregulated Behavior • The unregulated pricing of a natural monopolist violates the competitive principle of marginal cost pricing. • Marginal cost pricing – The offer (supply) of goods at prices equal to their marginal cost. • The natural monopolist’s profit-maximizing output also fails to minimize average total cost.

  9. Price (dollars per unit) Quantity (units per period) Natural Monopoly Average total cost Demand Unregulated p pA ATC = p (Normal profit) C pC Marginal cost B pB MC = p (Efficient) A MCA 0 qA qC qD MR

  10. Subsidy • Marginal cost pricing by a natural monopolist implies a loss on every unit of output produced. • A subsidy must be provided to the natural monopoly in order to provide efficient pricing.

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