Download 15-10 Regulation of Natural Monopoly

MICROECONOMICS: Theory & Applications
Chapter 15 Using Noncompetitive Market Models
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
9th Edition, copyright 2006
PowerPoint prepared by Della L. Sue,
Marist College
Learning Objectives
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Determine the relative magnitude of the deadweight
loss of monopoly.
Ascertain the extent to which, if any, monopolies
suppress innovations.
Explore whether government intervention can
promote efficiency in the case of natural monopoly.
Explore the concepts of iterated dominance and
commitment in the context of game theory models.
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The Size of the Deadweight Loss of
Monopoly
[Figure 15.1]
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Why Are the Estimates of the
Deadweight Loss Not Large?
 Estimates of the deadweight loss of monopoly
in relation to GNP are not large.
 Reasons:
– Deadweight loss is compared to the size of the
whole economy (GNP), not to the size of the
monopoly
– There are few, if any, pure monopolies in the U.S.
– We cannot measure the restriction in output in any
industry, only actual output.
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Other Possible Deadweight Losses
of Monopoly
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2 undesirable consequences of monopoly:
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Other effects:
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Restriction of output
Redistribution of income in favor of the owner of the
monopoly
In the absence of competition with other firms, the monopolist
is under less pressure to minimize (production) cost.
A monopoly may incur other costs (in addition to production
costs) to ensure continuation of its monopoly power.
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Do Monopolies Suppress
Inventions?
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Worthwhile invention: one
that allows a firm to produce
a higher-quality product at
an unchanged cost or to
produce the same-quality
product at a lower cost.
A worthwhile invention can
be profitable for a
monopolist.
Figure 15.2
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Natural Monopoly
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Natural monopoly – the
case in which the average
cost of a single enterprise
declines over the entire
range of market demand
Economies of scale extend
to very high output levels.
Figure 15.3
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How can policymakers do when
natural monopoly conditions exist?
 4 options:
– Leave the market alone
– Permit a monopoly to operate but to regulate its
activities
– Allow the government to own and operate the
facility
– Allow the government to accept competitive bids
from potential firms for the right to operate the
facility
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Regulation of Natural Monopoly:
Theory
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Public utilities – public
agencies charged with
regulating natural monopolies
2 pricing approaches:
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Average-cost pricing is more
practical
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Average-cost pricing:
AC=demand curve
Marginal-cost pricing:
MC=demand curve
Output is greater and price is
lower than if the monopoly
were unregulated
Monopoly’s owners receive no
profit
Figure 15.4
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Regulation of Natural Monopoly:
Practice
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Rely on the rate of return on invested capital
(accounting profit) earned by a monopoly because
complete knowledge of cost and demand conditions
is unattainable
Problems:
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The monopolist’s incentive to minimize cost is diminished.
Regulated rates reduces the incentive to engage in research
and development activities designed to develop new services
or new products.
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Government Ownership
 An alternative to rate regulation: public
ownership
 Drawback:
– The objective to ensure that P=AC attenuates the
incentive to innovate and/or minimize cost;
absence of a profit motive
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More on Game Theory: Iterated
Dominance
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Iterated dominance –
the concept of
eliminating any strategy
that is inferior to or
dominated by another
strategy
Table 15.1
(Continued)
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More on Game Theory: Iterated
Dominance (continued)
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Eliminating dominated
strategies
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Table 15.2
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More on Game Theory:
Commitment
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Commitment – the
strategy of adopting a
particular course of
action, constraining
one’s choice of
strategies, in order to
increase your
equilibrium payoff
Table 15.3
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