The potential problem with competitive pricing regulation of a natural monopoly is that : a. P <...

Question:

The potential problem with competitive pricing regulation of a natural monopoly is that :

a. P < ATC.

b. P < AVC.

c. P < MR.

d. P < MC.

Natural Monopoly:

A natural monopoly emerges when the cost to enter a particular industry is substantial and creates significant barriers for new firms to enter a market. Natural monopolies emerge as established companies assume dominant positions by having the economies of scale and the large-scale infrastructure that enables a competitive advantage over other firms. Examples of natural monopolies include utility and railroad companies.

Answer and Explanation:

The correct answer is d. P < MC.

A natural economy needs to achieve allocative efficiency where price (p) or average revenue (AR) equal marginal cost (MC). Excessive price regulation will potentially result in prices being less that marginal cost which results in losses. The latter results when average total costs (ATC) are greater than AR.

Natural monopolies are further challenged by price regulation when seeking continuous economies of scale which requires investments in infrastructure. The latter is often funded with profits as ATCs decline while increasing levels of output. However, excessive regulation and price constraints may compromise the expected reduction in ATCs and limiting the potential to maximize profits.

The resulting impact is the potential for reduced operating efficiencies resulting from aging and declining infrastructure. The combination of reduced income higher operating costs results in declining allocative efficiency and profit loss. The latter often results in the need for government subsidies or actions to segment the market or eliminate the natural monopoly.

Answer a, b, and c are incorrect.


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Natural Monopoly in Economics: Definition & Examples

from Intro to Business: Help and Review

Chapter 3 / Lesson 13
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