Question

Natural monopolies exist when it is less expensive for one firm to produce all of an industry’s output than it is for multiple firms to each produce a share of that output. Despite this cost efficiency, natural monopolies still produce an inefficient level of output. Using graphical analysis to aid in your answer demonstrate why this inefficiency exists and explain why there is no regulative course of action that a government can take to eliminate the inefficiency.

Answer 1

The inefficiency occurs because in a natural monopoly,the market is dominated by one company and absence of competition can lead to lack of innovation and lowering of output.

1.Lack of innovation:when a single company commands over a segment,Innovation is the first in line to take a major toll.Companies tend to scale back expenditure on R&D because even a weaker product sells since competition is non existent

2.Lowering of output:another fall back of natural monopoly is lowering of output.This is because to control the supply and demand,companies tend to stock up their inventory even when there is a demand supply imbalance.Higher prices can be commanded by the company even when marginal cost decreases

The govt can take regulatory actions and is in most cases doing so

Regulations in case of natural monopoly is hard to do because of the following

1.marginal cost and average cost cannot be obtained directly sometimes because most monopoly companies are very hard to be valuated

2.if the govt caps the cost,a simple resource imbalance can throw the company off balance and create a demand supply problem

3.it doesn't make sense to regulate costs because most of the times a natural monopoly is preferred over others because of lower cost involved.

The following graph shows relationship between cost and quantity.

When the quantity decreases cost decreases

Therefore a company entering late into the market might not be fully able to exploit the market due to a already existing behemoth in the market.Low cost product from the monopoly company can drive a start-up to bankruptcy because market has changed completely from the market that was present when the original company took it's first step.

Therefore an already saturated market is better to be serviced by a monopoly than multiple small companies