Question

Assume the government regulates a natural monopoly by setting a price ceiling equal to their marginal cost. (2 pts.)

What issue does this cause the monopoly?

What is a solution to overcome the issue?

Answer 1

Natural monopoly happens when firms fixed cost is high and variable cost is low. Hence such firms can supply total quantity demanded in market at much lower cost through economies of scale then other firms in market. This keeps market prices low and creates natural monopoly for one firm.

However when authorities impose fixed price ceiling this changes the market to perfect competition and reduces the pricing power of monopolistic firm and raises revenues for other firms in narket.

The solution to overcome issue is to optimise product offerings or keep fixed costs low to maintain margins. Similarly products can be bundled together to get better revenues and customers in long run.