Question

This chapter 12 has identified several strategies for dealing with natural monopolies and their associated inefficiencies. Alternatively, assume that you are a regulator and that the monopoly you face is able to price discriminate -- perhaps perfectly. Does this ability change the options you have for encouraging the efficient level of production? Would you choose to use this additional option? Why or why not?

Answer 1

If we consider a monopolistic firm selling a single commodity in separated markets. Demand functions & MCs can vary across markets. Initially the company establishes its monopolistic price in every market. The margin is price less MC, & the monopolistic margins vary. As an outcome, output is ineffectually distributed insofar as society is concerned. A given output is allocated effectually when the profit margins are equivalent, as the marginal social worth of output equals price less MC.

2 levels of the margin are taken into account - the arithmetic average of the monopolistic margins & the harmonic average. In every case the weights are the shares of the overall output. A uniform margin equivalent to the arithmetic average benefits customers in aggregate. The line of reasoning for this is general, as it depends only upon downward sloping demand curves , & it doesn’t depend upon the initial margins being the monopolistic ones. An inference of initial profit maximization, nonetheless, is that overall output is lesser with this uniform margin & the impact on social welfare can be positive/ negative. The harmonic average is below the arithmetic average, so all customers are at an advantage with the former. The lower margin has 2 more desirable features- it guarantees that overall output is above the monopolistic level if the demand functions are convex, & its the profit maximization uniform margin in case the demand functions are linear (so the company prefers it to the arithmetic average). Another type of regulation, equalizes the ratio of price to MC. This is especially relevant when the goods differ across markets & hence can’t be aggregated directly.

A regulator with complete info & a full set of tools would establish every price equivalent to MC & would fund any resultant losses thru a lump-sum transfer. If the regulator can’t make transfers then the 2^nd -best option is Ramsey pricing. This equalizes the product of the price spread (the margin divided by the level of price) & the PED & yields 0 profit to the company. The concentration instead is on piecemeal reforms to monopolistic pricing which have stout welfare properties & can be executed minus a large info requirement.