Quiz 13: Limiting Market Power: Regulation and Antitrust

An electric company in a city is considered to be a natural monopoly because the average cost of it reduces as it increases the production of its services. New electric companies find it difficult to compete against the existing company because of the decreasing average cost. If two electric companies are established, then the monopoly power of an existing company will vanish accordingly. A change in technology tends to reduce the cost of production. Reduction in the cost of production is likely to eliminate the natural monopoly since other firms will enter in the market.

Reduction in the cost of production leads to decrease the price of products. If the price of coast-to coast telephone calls has reduced by 20 percent, then a long-distance telephone company should decrease its price accordingly. If the price is reduced by only 2 percent considering 20 percent reduction in cost of production, then one would opine this practice as inequitable. Price should be reduced according to reduction in the cost of production. Reduction in the price can lead to an increase in the use of telephone services. People would increase their use due to reduction in the telephone charges. Thus, the idea of not reducing telephone charges according to decrease in the cost would not be considered as a good idea.

One would regard the practice of preventing price from falling as anticompetitive. If the price floor is imposed by a regulatory agency, then many new firms enter in the market, but this will not tend to increase the competition in the market. Consumers' benefit might be reduced if the price is prevented from falling. Price floor attracts new firms in the market causing an increase in the supply. The supply increases but the price does not decrease due to price floor. Thus, preventing decline in the price is a bad idea.