Question

Answer one of the following questions. Use diagrams where appropriate in your answer. I. (a) Using a diagram, explain what a natural monopoly is. What price should the government require a natural monopoly to charge? Explain, using your diagram (or a new diagram if you prefer). (b) Discuss the reasons why public production of goods and services may be less efficient than private production

Question 1 a & b thank you

Answer 1

a) A natural monopoly takes place when in an industry the most efficient number of firms is only one.This is because in a natural monopoly fixed cost is very high.It will not be a good decision for more than one firm to produce that good.For eg tap water.The cost of setting up a water plant is costly and so it is necessary to set one firm only

In case of a natural monopoly , market competition will not work and so government should regulate the price and output because in a unregulated market prices will be very high.Price cap regulation refers to the government regulation of public utilities like water , electricity etc.The price is set by the government many years in advance .Cost plus regulation on the other hand, refers to government regulation by taking into account the accounting cost and normal profit that the firm can earn.In the case of price cap regulation , the firm can earn profit if it can keep cost of production low.So the possibility of earning greater profits instead of average rate of profit under cost plus, gives incentive for innovation under price cap regulation.Cost plus regulation has problems and so the government has been using price cap regulation . In the diagram , it will be necessary for the firm to charge $9 , where the demand curve intersects average cost.

b)There is no evidence of greater efficiency of private sector than public sector.In many cases the private companies performed worse than public sector.For example in the telecom industry, private sector did worse than public sector in offering services.Health care is another area where this is a myth.For eg the governments Affordable care act is an eg of public health care system being more efficient.Public health care system provide universal coverage and can benefit from economies of scale.