Dec 11 2009
Monopoly prices – to regulate or not to regulate, that is the question!
Published by Jason Welker at 8:56 am under
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WikipediaCompetitively Priced Electricity Costs More, Studies Show – New York Times
The problem with monopolies, as our AP students have learned, is that a monopolistic firm, left to its own accord, will most likely choose to produce at an output level that is much lower and provide their product at a price that is much higher than would result from a purely competitive industry.
A monopolist will produce where its price is greater than its marginal cost, indicating an under-allocation of resources towards the product. By restricting output and raising its price, the monopolist is assured maximum profits, but at the cost to society of less overall consumer surplus or welfare.
Unfortunately, in some industries, because of the wide range of output over which economies of scale are experienced, it sometimes makes the most sense for only one firm to participate. Such markets are called “natural monopolies” and some examples are cable television, utilities, natural gas, and other industries that have large economies of scale. (click graph to see full-sized)
Government regulators face a dilemma in dealing with natural monopolistic industries such as the electricity industry. A electricity company with a monopoly in a particular market will base its price and output decision on the profit maximization rule that all unregulated firms will; they’ll produce at the level where their marginal revenue is equal to their marginal cost. The problem is, for a monopolist its marginal revenue is less than the price it has to charge, which means that at the profit maximizing level of output (where MR=MC), marginal cost will be less than price: evidence of allocative inefficiency (i.e. not enough electricity will be produced and the price will be too high for some consumers to afford).
Here arises the need for government regulation. A government concerned with getting the right amount of electricity to the right number of people (allocative efficiency) may choose to set a price ceiling for electricity at the level where the price equals the firm’s marginal cost. This, however, will likely be below the firm’s average total cost (remember, ATC declines over a WIDE RANGE of output), a scenario which would result in losses for the firm, and may lead it to shut down altogether. So what most governments have done in the past is set a price ceiling where the price is equal to the firm’s average total cost, meaning the firm will “break even”, earning only a “normal profit”; essentially just enough to keep the firm in business; this is known as the “fair-return price”.
Below AP Economics teacher Jacob Clifford illustrates and explains this regulatory dilemma. Watch the video and see how he shows the effect of the two price control options on the firm’s output and the price in the market.
The article above examines the differences in the price of electricity in states which regulate their electricity prices and states that have adopted “market” or unregulated pricing, in which firms are free to produce at the MR=MC level:
“The difference in prices charged to industrial companies in market states compared with those in regulated ones nearly tripled from 1999 to last July, according to the analysis of Energy Department data by Marilyn Showalter, who runs Power in the Public Interest, a group that favors traditional rate regulation.
The price spread grew from 1.09 cents per kilowatt-hour to 3.09 cents, her analysis showed. It also showed that in 2006 alone industrial customers paid $7.2 billion more for electricity in market states than if they had paid the average prices in regulated states.”
The idea of deregulation of electricity markets was that removing price ceilings would lead to greater economic profits for the firms, which would subsequently attract new firms into the market. More competitive markets should then drive prices down towards the socially-optimal price, benefiting consumers and producers by forcing them to be more productively efficient in order to compete (remember “Economic Darwinism”?). It appears, however, that higher prices have not, as hoped, led to lower prices:
“Since 1999, prices for industrial customers in deregulated states have risen from 18 percent above the national average to 37 percent above,” said Mrs. Showalter, an energy lawyer and former Washington State utility regulator.
In regulated states, prices fell from 7 percent below the national average to 12 percent below, she calculated…
In market states, electricity customers of all kinds, from homeowners to electricity-hungry aluminum plants, pay $48 billion more each year for power than they would have paid in states with the traditional system of government boards setting electric rates…”
That $48 billion represents higher costs of production for other firms that require large inputs of energy in their own production, higher electricity bills for cash-strapped households, and greater profits and shareholder dividends for the powerful firms that provide the power. On the bright side, higher prices for electricity should lead to more careful and conservative use of power, reducing Americans’ impact on global warming (since the vast majority of the country’s power is generated using fossil fuels).
Here arises another question? Should we be opposed to higher profits for powerful electricity firms if their profits result in much needed energy conservation and a reduction in greenhouse gas emissions? An environmental economist might argue that if customers are to pay higher prices for their energy, it might as well be in the form of a carbon tax, which rather than increasing profits for a monopolistic firm would generate revenue for the government. In theory tax revenue could be used to subsidize or otherwise promote the development and use of “green energies”.
Whether customers paying higher prices for traditionally under-priced electricity is a good or bad thing depends on your views of conservation. But whether higher profits for a powerful electricity company are more desirable than increased tax revenue for the government are beneficial for society or not seems clear. If we’re paying higher prices, the resulting revenue is more likely to be put towards socially desirable uses if it’s in the government’s hands rather than in the pockets of shareholders of fossil fuel burning electricity monopolies.
Discussion Questions:
- Why do governments regulate the prices in industries such as natural gas and electricity?
- Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
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About the author: Jason Welker is a teacher at Zurich International School in Switzerland, where he teaches Advanced Placement and International Baccalaureate Economics. Jason was an international school student in Malaysia before studying economics at Seattle University then earning his Masters in Education. He calls Seattle and Northern Idaho home. In addition to maintaining an economics wiki and this blog for economics student and educators, Jason also gives presentations on using Web 2.0 tools in education at workshops and conferences around the world. His economics wiki won the 2007 "Best Educational Wiki" award from the "EduBlog Awards". Related posts:
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I believe that all monopolies except natural monopolies should be regulated by the government to some extent. Let’s face it, no one wants to get ripped off by monopolies who are charging outrageous prices for their product. It is never wise to regulate a natural monopoly because it is most effective if a firm has a natural monopoly and if there is a price ceiling, it will hurt both the firm and society as well because there are no other substitutes for that natural monopoly and it is not efficient for other companies to produce the same product.
Governments regulate the prices in industries such as natural gas and electricity because these natural monopolies result in allocative inefficiencies. Since these monopolies, like any other firms, seek to maximize profits, they will produce at a level were MR = MC. But because a monopoly’s MR is less than price, the MC at that level will be less than price, which means allocative inefficiency, or that consumers are demanding more than what is actually produced. In other words, an underallocation of resources will occur in the monopoly, as the monopolist will limit its supply to keep its price at the profit-maximizing level, and there will be a loss in consumer surplus, as the price will be too high for some consumers. Therefore, the government steps in to set a price ceiling where the price equals to the marginal cost, thus resulting in allocative efficiency. But because this price is usually below the monopolist’s ATC, the government resorts to the alternative of setting the price ceiling where price equals to the firm’s ATC, or the “fair-return price”, where the monopolist will earn a normal profit.
De-regulation of the electricity industry might eventually result in lower prices in the long-run because the removal of price ceilings would lead to greater economic profits, thus attracting new firms into the industry. Increased competition would then force greater productive efficiency from the firms in the industry, who with lower costs, can sell their product/service at a lower price than its competitors, thus driving the price down closer to the price where allocative efficiency is achieved.
Monopolies are not allocatively or productively efficient, meaning, they are market failures. Which is why governments set price ceilings inorder to insure efficiency and prevent market failure. This also prevents the monololist from setting so high a price, some consumers cannot or are not willing to pay.
If governments deregulate electricity, the idea is that the high profits earned would attract new firms which would increase competition, and consequently, drive prices down. This would ensure productive and allocative efficiency which is good for the market.
Well, first of all natural gas and electricity are primarily considered by most people to be inelastic goods. Even if natural gas and electricity are expensive, consumers will still buy them because they are important to have. I mean I’m pretty sure that if the price of electricity was a huge rip off, my parents would still pay for it because we need lights to see at night time and power for computers to do work. Therefore, government regulates the electricity and natural gas industries, since they would otherwise be able to charge ridiculous prices and still make a hefty profit.
In contrast, however, deregulation would allow consumers to get sick of the high prices and begin to look for alternatives. This would, therefore, open up more competition. In the end, the monopoly would either have to significantly cut down its prices, or new firms entering the industry would be able to steal consumers. However, entry into an industry with a monopoly is very difficult and that could be an explanation as to why prices of electricity have only risen.
Contrary to the general thought that government intervention in economics actually harms the economy, regulations for a monopoly actually benefits society. The price ceiling at P=MC allows for greater allocative efficiency, and also increases total surplus, and removes deadweight loss. Utilities such as water and electricity are basically inelastic, and it is completely unfair for these natural monopolies to simply charge whatever they want. Governments still act in the interests of the people, and thus regulating some monopolies serve that very just purpose.
All natural monopoly need government regulation to control a monopoly from manipulating people’s inelastic needs for utility service. But recently, state governments have been de-regulating monopolies, believing that increased competition would force firms to more productively efficient; however, the governments neglect the higher ATC when a natural monopoly dissolves into several smaller firms.
1. Governments regulate the prices in industries such as natural gas and electricity because these industries are natural monopolies. The nature of these markets, in which great economies of scale are extended over a wide range of output, leads to a natural monopoly in which the single producer who controls the entire industry is apt to set profit-maximizing price and output. However, at the monopolist’s profit-maximizing price and output, P doesn’t equal MC, and so resources are underallocated; this is why governments might regulate the prices in such industries- in order to try to push the industry into better allocative and productive efficiency.
2. A state government would think that de-regulation of the electricity industry might eventually result in lower prices in the long run because of the theory that de-regulation would leave the electricity firms free to set high prices and earn more profit. This profit would attract new firms into the market, creating more competition and thus driving the prices downwards. In reality, however, this theory has been proven wrong as the economies of scale in this naturally monopolistic market have led to increased costs as new firms attempt to enter the market, only driving prices higher than ever before.
It’s clear that the reason why the deregulation of the industry did not attract many other firms into the industry is because of high barriers to entry, mostly caused by economies of scale. Obviously, many firms would be attracted to the lucrative profits which a pure monopolist is receiving, but since the production of electricity is so costly, it would be extremely difficult for new firms to compete with the currently monopolistic firm, thus there was no drive down of price. This is the reason why governments regulate natural monopolies in the first place. If firms could so easily enter the industry, then there would be no need for regulation since the natural state of things would be for equilibrium to be restored through an influx of producers. Therefore there should be less regulation of competitive industries, but natural monopolies should certainly be regulated
1.Governments regulate the prices in industries such as natural gas and electricity because set a price ceiling where the price is equal to the firm’s average total cost, meaning the firms would be earning only a normal profit; just enough to keep the firm in business instead of charging high price to earn high profits.
2.A state government thinks that de-regulation of the electricity industry might eventually result in lower prices in the long-run because if the price is too high, less people would be willing to buy it; therefore, less profits would earned. In order to maximize profits, firms needs to lower price eventually.
Governments regulate monopolies that are crucial to everyday life (such as electricity and water) so that more consumers are able to obtain these goods. The companies that governments usually regulate are the firms that produce necessities, so the government needs to make sure that the lower-income families are also able to pay for these non-luxurious goods. If they were merely luxuries, then the government has no reason to regulate its price.
Even though in the long-run, this deregulation may lower the prices of these goods, this will take a long time since these monopolies have reached such a large economies of scale. It will be years (maybe even decades) until it’s possible. Therefore, during these years while other companies are trying to build up its size to compete, the consumers are going to be suffering.
But another way to look at it is that it’s a small price to pay for lower prices in the future.
1. Governments regulate the prices in industries such as the natural gas and electricity because the two are natural monopolies. And also the two industries listed are necessities to everyday life. As we discussed in class the other day, by regulating the price, governments can help the lower income families by providing accessible necessities.
2. Deregulation of the electricity industry might eventually result in lower prices in the long-run because it would let other companies have no restriction in setting higher prices to make more profits. In time consumers are only going to look for other alternatives.
1.Prices would be regulated by the government in order for Natural Monopolies to become allocatively efficient. By looking at the graph above, all profit maximizing firms will produce where Marginal Revenue will equal Marginal costs. The problem producing at that point is that the firm is allocatively inefficient where price does not equal marginal costs. Therefore, governments will try to regulate the price of such firms so that those firms will achieve P=MC or allocative efficiency.
2.The government believes that deregulating prices for those industries will eventually drive prices down because of increasing profits for the industry. With increasing profits, other firms will be attracted to the sweet, delicious smell of “profit pie” thus creating competition within that industry. With increasing competition, prices will be driven down to the socially optimal price thus achieving what the government wanted in the first place.
They must reach allocatively efficient areas. The government needs to have these necessities being produced at the right amount so that there won’t be shortages for something as crucial as electricity for people.
De-regulating the industry might cause other firms to come in and COMPETE with the established ones. However, this is not the case because of ECONOMIES OF SCALE. Natural monopolies are better because they are generally more efficient and cost less than if a competing firm was to enter and cause ATC to be higher for both.
1. Natural gas and electricity are natural monopolies, meaning they have extended economies of scale. Since they’re profit-maximizing, they tend to produce at a quantity where MC=MR; this is a lower quantity and higher price than would make it allocatively or productively efficient, and resources are underallocated. Governments would thus try to control the monopoly by setting a price ceiling in an attempt to produce greater efficiency. However, this usually doesn’t work either, as the socially-optimal (or allocatively efficient) output and price where P=MC often falls below the minimum ATC, causing the monopoly to operate at a loss and eventually shut down. The compromise is the fair returns point, at which P=ATC, so the firm is at least making a normal profit and is more efficient than at the profit max point.
2. Deregulation, in theory, allows monopolists to set higher prices and earn an economic profit, thereby attracting more firms into the industry and driving down the prices in the long-run. However, the nature of such natural monopolies prevents this from actually happening; the great economies of scale make it difficult for new firms to enter into the market, and would result in overall inefficiency.
A bit tangential, but is it that bad that gas prices are so high? Maybe it’ll finally push some people towards alt. energy sources..
Governments regulate the prices in such industries because they are necessities and therefore their prices should be low enough for everyone to have an access. So government can help lower income families to purchase those good by regulating the industries.
Because de-regulation will mean that the price of electricities will be really high, earning firms in that industry profit, and therefore will attract new firms to enter the industry. And profit brings down the price. But in the case of such natural monopolies, since it is hard for new firms to enter the industry, the price will remain high and the overall efficiency will drop.
The thing with natural monopolies is that most of them are bare necessities. From the people living on government aid to the millionaires, we need these utilities, thus it is the government’s role to make it affordable to everyone. For other monopolies such as De Beers’ Diamonds, it is more of a luxury good and is not necessary for our survival. Thus keeping these unregulated is not as big of an issue as the utilities.
As for de-regulation, the consumer will suffer for the period of transition until a new firm steps in to challenge/compete with the existing monopoly. However, even after deregulation it may be too difficult for other firms to enter and gain market power. The original monopoly is already so vast and branched out that the new firm may not have enough money for the overhead costs.
Governments regulate the prices in industries such as natural gas and electricity because those products are necessities. Every human beings need those products to carry on their lives. Since people know that without those products they will not be able to survive, they will pay to purchase those products even if they are sold at extremely high price. Therefore, government should restrict the firms who always try to make the most profit.
However, some state government thinks that de-regulation of the electricity industry might eventually result in lower prices in the long-run because at first the de-regulation gives high profits to the firm but eventually more firms will be interested in this market and join in. If more companies join in, the firms will compete each other and the price will eventually drop. However, this is only in a long run, at least more than 3 years.
Governments regulate industries that produce necessities such as these because they are just that, necessities. Some people cannot afford the good at the monopolistic price and therefore governments need to regulate these prices. More so, profits are evidently not producing more competition and therefore defeats the purpose of allowing free markets.
They would think de-regualtion would result in lower prices because the profits of the industry would attract new firms creating competition and consequently creating efficiency.
I think monopolies would be better if they were not regulated in the long run. Because as we can see from the fuel market that there have been no advances in technology for the last few decades and this is because companies are not willing to and possibly not able to spend money on technological advancements which would bring greater production efficiency. If monopolies were allowed to grow by themselves, in the end they would all be able to make a profit at the price where most people could afford it because of economies of scale and technological advancements.
In my opinion, regulating prices and government intervention are very tricky businesses; firstly, because it is very difficult to judge how much intervention is required. Secondly because the second you get a government intervening in a “free market economy”, it is no longer a free market, and this may leads to socialism scare. It is like we are seeing at the moment, the government cannot buy companies who are in debt, because that would quite simply be leading towards government run enterprises which is a socialist ideal. For this reason, the government have to give bail out money to companies, which cannot be tracked or controlled by the government, meaning that it may not even go towards fixing the recession which is leading to a lack of liquidity in the economy. When it comes to monopolies, in my opinion they are unfair, because they are basically the perfect chance for companies to stitch up the consumers. However, it is my opinion that the government cannot instigate price ceilings to regulate the prices; no government has the ability to regulate every monopoly in the world, or even create a sense of fairness to them, because prices are very individual to the products, no two monopolies can be limited the same way. So who are the government to create figures and rules which are “fair”, because what is in the best intrest of the government may not be in the best interest of the economy, or the marcket.
In these industries, there is usually a company with a monopoly over the market. As a result, they will do what most monopolies do and set the price where the marginal costs intersect with the marginal revenue. This results in relatively high prices and a low output level. This allocative inefficiency hurts the consumer who has to pay more for a good than its cost to the firm. Governments step in, setting price ceilings and using other techniques in order to bring prices to a reasonable point, often where the average costs curve intersects the average revenue curve.
The thought process behind believing t hat deregulation would result in lower prices results from a narrow view of the idea of markets and competition. They feel that if competition was open to anybody, firms would compete for the most efficient way to provide electricity which would result in lower prices. They believe that this is what competition will foster.
Jordan,
Your point is fine and well when in the context of an economy that is not hurdling towards depression. The government involving itself within the complicated world of finances can create an imbalance in the market structure and political strife such as socialism, an ideology spat on by the majority of American society. However, when in the context of current economic times, these “bailouts” are necessary due to the fact that without a government rescue, some firms will bring down the whole economy with them if they fall. Due to the fast action of many governments across the world, this situation was mostly avoided. But take for example one instance in which the United States decided not to rescue Lehman Brothers. Their fall shook the very timbers of the economy and many were afraid we would spiral into an economic depression. So I understand your point but the context must definitely be considered when arguing against government intervention.
In a monopoly, a firm can set their prices at the profit-maximizing point where MR=MC because the lack of competition results in inelastic demand. However, this is often bad for the consumer, as marginal cost is less than price. This results in allocative inefficiency. In order to make prices more reasonable for the consumer, the government sets a price ceiling at the break-even point. Some states, however, believe that deregulation will in fact result in lower prices. The supernormal profits a monopoly makes should attract other firms, and increased competition will push down prices. Obviously, that’s not happening in this case.
Trevor,
I think you’re a bit quick to say that supporters of deregulation have a “narrow” view. Increased competition does actually lead to lowered prices. This is why, in a perfectly competitive industry, supernormal profits are impossible in the long run. Increased competition pushes the supply curve to the right, lowering prices and eliminating supernormal profits. Deregulation hasn’t lowered prices here, but that doesn’t mean it never works.
1. Why do governments regulate the prices in industries such as natural gas and electricity?
Governments regulate the prices in industries such as natural gas and electricity by setting price ceilings where the price is equal to the firm’s average total cost so the firm can continue to operate under normal profits. This price ceiling is called the “fair-return price.” The intention behind this policy is to restrict the firms’ exploitations of its monopolistic powers. If the price ceiling is not set in the industry, the firm will continue to sell their products or services at higher prices at a relatively low output. In doing so, they would continue make tremendous amounts of supernormal profits. Essentially, the government regulation on prices will put a stop on these exploitations.
2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
A state government would think that de-regulation of the electricity industry might eventually result in lower prices in the long run because accordingly to Economics Darwinism, more competitive firms will be attracted to industries that are making large amounts of supernormal profits. Such entry into the industry would force the pre-existing firms to produce more effiecinetly in order to compete with its rivals.
Trevor>>
But us as consumers, don’t we want to have lower prices on products? I generally think that because economy is driven self-interest, if anything is beneficial for us individually, people tend to become supporters of that. And true, it can be said the other way, if we are the CEO of a firm that has monopoly over a certain industry, sure, we would want to make as much as profit we can make. We NEED to look at economics from a multiple lenses, not only your personal views about it.
1. In some cases the government needs to regulate the prices in industries because if there is only one provider for electricity, for example, the company has the power to change the price to whatever they need it to be, meaning they could increase the price a lot to maximize their profits. The government regulating the prices stops them from getting out of control and overpricing the goods.
2. De-regulation of the electricity industry might eventually lead to lower prices in the long-run because the company would initially increase their prices a lot and the amount of consumers would decrease actually causing a decrease in profits. Because of this, the company would eventually decrease its prices to appease the consumers, so the price would limit itself naturally.
In some cases the government needs to regulate the prices in industries because if there is only one provider for electricity, for example, the company has the power to change the price to whatever they need it to be, meaning they could increase the price a lot to maximize their profits. The government regulating the prices stops them from getting out of control and overpricing the goods.
De-regulation of the electricity industry might eventually lead to lower prices in the long-run because the company would initially increase their prices a lot and the amount of consumers would decrease actually causing a decrease in profits. Because of this, the company would eventually decrease its prices to appease the consumers, so the price would limit itself naturally.
Margaret,
I agree with you about the profits attracting ne competition, I didn’t think of that. But if the government only wants one company in the electricity industry what would happen would the prices still decrease in the long run?
Sara
Governments regulate prices in such industries because they are natural monopolies and if left unregulated, will take advantage of the consumer by hiking up prices and minimizing output. They need to be regulated so that we, the consumers, can all be satisfied. If energy were left unregulated, the prices would be obscene and it would be very difficult for a large majority of people to afford.
A state government might think that de-regulation of the electricity industry would lead to lower prices in the long run because more firms will enter the industry and force the price down. However, seeing as the electricity industry is a natural monopoly, I see this prediction to be untrue. A natural monopoly provides many barriers to entry and I don’t think there will be much competition entering the industry due to this. Thus, the natural monopolies must be regulated.
Hey Sara,
The electricity industry is a natural monopoly so there is no reason for them to ever decrease prices because they are the only firm in the industry, so I dont think that that is what state governments think will cause price decrease in the long run, no?
1. Governments regulate prices in industries such as natural gas and electricity because these industries often have natural monopolies. As they are monopolistic, these firms are price-makers which means that they determine the price which the consumer will pay for their good or service. If these firms raise their prices, some people will not be able to afford enough of what they offer—for example, electricity, water, or natural gas. If the government places a price ceiling on the firm, then they will not be able to hurt consumers by limiting their access to necessities. The firm will also not be able to make supernormal profits at the expense of the consumer.
2. A state government might think that deregulation of the electricity might result in lower prices in the long run. This is because of the competitiveness of the market. Firms by nature want to make a profit. If a firm with a natural monopoly exists under price ceilings, it will only be making normal profit. However, if the firm is deregulated and has high prices, then it may make supernormal profits. This would attract new firms to the industry. The firms would be in competition and would both lower their prices to attract customers. Therefore, some speculate that deregulation would lead to lower prices.
Hey Dennis,
I agree with you that monopolies have barriers to entry. I was just wondering what specifically those might be for the electricity industry. There are large sunk costs and I am sure that it would take a while to begin making a profit, but I can’t think of many real, regulated barriers to entry. The only ones that come to mind are safety regulations regarding electricity. Can you think of any others?
Great contribution,
Chamonix
Industries such as natural gas and electricity, or in other words monopolies, try to obtain maximum profit by producing at the point where MR=MC. This makes them allocatively inefficient, producing at a price higher than both AC and MC, and productively inefficient, producing at a cost that lies higher than the lowest point on the AC curve. Therefore these industries produce at higher prices and lower output, and this is not beneficial to the consumers – so governments will regulate prices.
The state government assumes the de-regulation of the electricity industry might encourage new firms to join the market, because of the possibility of earning supernormal profits, and thus increase competition and lower prices.
Natural gas if left unregulated would fair from cohesion, monopolies, and trusts. Also if a monolpoy emerged the fact that natural gas is a very limited resource prices would increase at an alarming rate. Also the use of natural gas may be harmful to future generations which is an unrepresented consumer base. The barriers to entry strengthen already advantaged monopolies. The arguement against that is with the creation of a more global market with more choices consumers do not have to settle for a certain, type, brand, or choice.
Deregulation in any sector lowers prices because regulation as a responsibility is shifted from the government to the consumer.
Eline
I agree that the government does make that assumption but at this point especially with localities in place deregulation is more of a ideological theory then a feasible issue. I like your explanation, I had been having a hard time understanding MC=MR before I read yours and Chamonixs reply.
Sara
I agree with you completely on the idea of why would they want to lower prices if they are the only competitors because of strong barriers of entry
1.Why do governments regulate the prices in industries such as natural gas and electricity?
Government would want to regulate natural gas and electricity prices because it would ensure that every household and individual would have access to these necessities, in order to cook, have lights, watch TV (less of a priority, to be sure), etc.
2.Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
The theory is that, if deregulalation results in economic profits for the electric industry, this would attract other firms into the market, and this would force down prices to the socially-accepted price.
Why do governments regulate the prices in industries such as natural gas and electricity?
Governments regulate the prices because if they didn’t, the firms would raise their prices until MR=MC, which could be a price that many consumers couldn’t pay. As the industries are needed for living, the government often subsidizes or places a ceiling on the price so that prices are reasonable for the average consumer.
Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
If the price raised high enough, some new firms might be able to afford to enter the industry, and turning it into an oligopoly, where both firms in the long run, would provide competition for the other, eventually lowering the price.
Indeed, as most people have already mentioned, governments use regulation to prevent firms raising prices to their profit maximization which invariably results in lower output but higher prices: logically, this leads to under allocation of resources, inefficiency, and angry consumers. Thus, governments usually establish price ceilings to avoid such situations.
However, other types of governments believe that de-regulation is more appropriate, since if the so-called ‘natural monopoly’ is enjoying supernormal profits, due to their profit maximization policy, the situation would attract more eager firms into the industry, and thus, through increased competition, lower the prices and achieve efficiency. Nevertheless, if we consider such theory, I would define the term ‘natural monopoly’ as obsolete, since such firms are only behaving as classic monopolies.
Felipe,
I definitely agree with your point about watching TV being a crucial factor for our survival, and I utterly like the term ’socially-accepted price:’ it is quite original and true. In addition, you went further in your interpretation of the question, as you not just explained the fact that natural monopolies are prompt to under allocate resources, but you also explained why people need the efficiency obtained from regulations, I mean lights, cooking and of course, unforgettable, watching TV.
Good comment, Priya.
I hadn’t thought of the scarcity of gas affecting its increase in price, actually it is a very good point and the state government should have thought of that instead of assuming de-regulation would lower prices. However, the reasons you stated for lowering of prices after de-regulation are not very accurate; as far I know, the actual reason is increased competitivity.
Eline
1. Why do governments regulate the prices in industries such as natural gas and electricity?
Industries such as natural gas and electricity are natural monopolies. This means that there are large economies of scale that would drive costs down. These industries are also essential goods as society is so heavily dependent on such forms of energy. Because of these factors, governments have to regulate prices in order to stop the firms from over pricing on essential goods, and also stop added competition from reducing economies of scale and increasing prices.
2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
A stat government might think that de-regulation of the electricity industry might eventually result in lower prices in the long run because the abnormal profits would attract new firms into the market. This would in turn, increase competition and drive down prices.
Hey Eline,
What do you think would be a more effective stance for the government to take concerning these natural monopolies? Do you think that the De-regulation/ increasing competition is the way to achieve the best prices for consumers, or government imposed price ceilings?
-Issa
As Jason previously (and correctly) stated, the govt. regulates the price on things such as natural gas and electricity to prevent the firm from producing where MR=MC, a price some consumers cant afford. However, there is another reason the government would do this. Because the government regulates prices, the firm is better achieving allocative efficiency. What this means is that basically the firm is producing the right goods, for the right people, at the right price. Without the governments price regulation, the firm may be inefficiently allocating their resources.
1. Why do governments regulate the prices in industries such as natural gas and electricity?
Governments regulate the prices in industries such as natural gas and electricity in order to achieve allocative efficiency so that the right amount is being produced for an affordable price to the consumers.
2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
A state government might think that de-regulation of the electricity industry would lower prices as an other firm could recognize that there are profits to be made and join the market , which (in the long-run) would increase supply, shifting it to the left and lowering the price.
* would increase supply, shifting it to the RIGHT and lowering the price
Governments would want to regulate the prices in a natural monopoly or even normal monopolies because they don’t want an under efficient market in their economy. They will regulate the prices so that both the consumer and the firm benefit equally from the trade of the firms. If left to operate where the firm wants the price will be where MR=MC and many consumers will not benefit from the price being there so since the product is necessary the government must regulate the price.
If the price was left then new firms would be able to join the market because they can see the profits that can be made from joining the industry. So the supply would shift to the left and the price would go down.
1. Why do governments regulate the prices in industries such as natural gas and electricity?
Electricity companies and Natural gas companies are examples of a monopoly. The government regulates the prices of these industries to achieve allocative efficiency. If the government did not do this then the firm’s would produce at the level which MR=MC, to maximize profit, which does not allocate the resources of the firm efficiently.
1. Because these industries are monopolies, they have a profit maximization point that is unfavorable to consumer surplus. This also results in a dead weight loss and this point is therefore allocatively inefficient. In order to maintain allocative efficiency, the government will regulate the product prices.
Governments regulate the prices in industries like natural gas and electricity to protect the consumer from harmful monopolies. Monopolies tend to sent unfair prices for their services, which means that their prices are much higher than the actual cost of operating the firm. This causes allocative inefficiency. As a result, the government may choose to regulate the prices in some industries to make sure that services remain affordable to the consumer.
Governments think that, through de-regulation of the electricity industry might result in lower prices because of competition between firms. Typically, when one firm is making a supernormal profit, other firms are drawn to the industry in hopes of making a high profit as well. However, the additional competition causes all the firms to lower their prices, thus eliminating supernormal profits. In the long run, firms will set lower, more competitive prices to attract more business.
Hey Masaya,
I think it is really interesting that you mention Darwinism in your response. Essentially, the competition between firms is survival of the fittest. Do you think that small firms have any advantages when facing a monopoly? I think that would depend on how efficient the monopoly is, as well as on the industry in question.
- Catherine
Governments regulate prices in some industries because they are natural monopolies such as electricity, gas and water. The government has to regulate the prices there as otherwise these industries will take advantages and set the prices high for products that are needed so automatically the customers are forced to buy the product at a high price and a lot of customers will not be able to afford the needed product.
A state government might think that de-regulation of the electricity industry would make that lower prices will be available because more firms will enter the electricity market and this will make competition for all the firms and so the prices will lower. This might be a realistic idea.
Priya
I really like how you mentioned the point about the fact that there is only a limited amount of natural gas and that this will lead to a high increase in price if the government wouldn’t regulate the price.
Vica
1. Governments regulate the prices in necessary industries such as electricity because these industries tend to be natural monopolies. For these monopolies there is a wide range of output over which they experience economies of scale, causing them produce at a low level of output and at a high price. The quantity produced will be where marginal cost equal marginal revenue and the firm makes most profit. The problem is that since the firm is the industry, these necessities such as natural gas will be produced at allocative inefficiency, meaning that there will be too little produced at a too high price to satisfy society’s needs. It is in the government’s interest to provide the right amount of electricity to the right number of people. This is why most governments set a price ceiling equal to the average total cost, allowing the monopoly to break even.
2. De-regulation of the electricity industry would mean that the firm can produce at its profit maximization point, and would lead to greater profit. This would attract more firms into the industry, making the market more competitive. The competition between the firms in the electricity market would force the prices down in the long-run to the price and level of output that is needed by society.
Governments regulate the prices in industries such as natural gas and electricity because the firms in those industries tend to be natural monopolies. This means that there are large economies of scale, which causes the costs for the firm to decrease, allowing them to earn abnormal profits. In order to increase profit, the monopolist restricts the level of output in order to raise the price. Although that is beneficial for the monopolist, it can hurt society because the products are being under-allocated. In order to solve this problem, the government will place a price ceiling which is lower than the original price, which increases the level of output to satisfy society’s need and causes the monopolist to earn normal profits.
A state government would think that de-regulation of the electricity industry might eventually result in lower prices in the long-run because the natural monopolist will earn large abnormal profits. When other firms realize that such high profits can be made in that industry, they will want to enter that industry, establishing competition between the two firms. In the long run, that would lead to a decrease in price since the prices would be competed down to equilibrium price.
1. Why do governments regulate the prices in industries such as natural gas and electricity?
First of all, the utility industries such as natural gas and electricity are those that can be considered natural monopoly. Also, in order for these firms to be natural monopoly, it must have very large economies of scale, that means eventually, the costs to produce will decrease, and therefore firms can earn abnormal profits. Moreover, a goal of a firm is to maximize their profits, so the monopolist with no restriction and regulations, might want to also maximize its profits by lowering the output, and therefore increase the price. Because of this, governments will regulate the prices in those utilities industries, keeping them just breaking even, by using the “fair-return price”. This lowers the price of the product, as a result increases the output, but still keep the firm running.
2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
If there are no regulations whatsoever on the prices of the electricity industries, in the short-run, the industry will charge higher prices, and they get more abnormal profits. In the long-run, there will be firms that are attracted to the profits being made in the industry, and therefore more firms will enter the market, breaking the monopoly state. As a result, there will be competition between firms, and drives the price lower.
1.Why do governments regulate the prices in industries such as natural gas and electricity?
Governments regulate the prices in industries such as natural gas and electricity because those goods are necessities for the population of a country and unregulated, the prices would be extremely high and the quantity supplied extremely low since companies that produce/supply electricity and gas are in a monopoly.
2.Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the long-run?
A state governemnt would think that de-regulation of the electricity industry might eventually result in lower prices in the long run because the high economic profits a monopolistic firm supplying electricity makes attract other firms. Therefore more firm would enter the market and the competition would lower the price. But this doesn’t work out because the barriers to entry are (almost) impossible to overcome.