International Economics Trade Theory and Policy

Question: Discuss about the International Economics Trade for Theory and Policy. Answer: Introduction A natural monopoly is described as a different type of monopoly that takes place when there are tremendously high fixed costs of distribution. A natural monopoly takes place in such industries that requires raw materials as well as other identical factors in order to operate. As a result, government allows natural monopolies to exist as they find it sensible for an economy. The most popular example of natural monopoly is that of utility industry. Natural monopolies mostly takes place due to high cost structure in the industries (Vikharev, 2013). The essay provides a brief overview about why governments may want to set the price charged by natural monopolies at the level where the demand curve cuts the average total cost curve. Limited resources of an industry are used by natural monopolies in an efficient manner in order to offer the lowest unit price to customers (Nizovtseva, 2013). The market structure is analysed along with the extreme forms of market that includes both perfect competition as well as monopoly. The essay highlights about the regulation of the government and also economies of scale under natural monopoly. Analysis Market structure in economics is defined as the organizational and other features of a market. A monopoly is a market structure in which there is a single producer or seller of a commodity. Entry into such a market is limited due to higher costs as well as other impediments that may be both economic and social. Government mostly generates a monopoly over an industry that is desires to control, for example electricity (Dunne, Klimek, Roberts, Xu, 2013). The above figure shows the monopoly market structure where there is a single producer as well as seller of a particular product. As such, under this market structure there is no difference between a firm and an industry. Super-normal profits are maintained in the long-run under the monopoly market structure. At profit maximization, MC = MR where price is P and output Q*. The price AR is above ATC at Q*, where super-normal profits takes place (Williams, 2016). Another extreme form of market structure is perfect competition that is also regarded as a hypothetical market where there is large number of competition. Under this market structure, there is no barrier to entry and exit where the firms produce homogeneous and similar products. Under perfect competitive market structure, there are several firms in the market and there is no need for regulation of the government. There is perfect knowledge with no information failure as well as time lags in the flow of information. Under this market structure, the sellers do not have an independent price policy (Thomas, Lubinda, Angula, 2015). The diagram shows the change of a firm from a perfectly competitive market to a monopoly market. Firms mostly earn normal profits under this market structure where price is equal to the marginal cost. Firms mostly produce a quantity of Qm at a price Pm. The intersection of the demand and supply curve helps to evaluate the price and quantity of a product. The diagram shows that demand no longer stays perfectly elastic when it is shifted from perfectly competitive market to a monopoly market. Under the monopoly market structure, marginal revenue curve is below the average revenue curve (Boeri Van Ours, 2013). The structure of a market is imperative to be acknowledged for a firm as it helps to determine the overall firms in the market. It also helps to conclude the extent to which the industry is vertically integrated. Under this market structure, economies of scale are very efficient so that minimum effectual scale is not accomplished. The lowest level of output at which all scale economies are exploited are termed as minimum efficient of scale. MES can only be accomplished when a single firm is able to compete in the market. The government has a tendency to nationalize and regulate the economy, as there is a prospect to exploit the monopoly power. The disadvantages that are associated with natural monopoly are that it includes low quality commodities as well as higher prices. The lack of competition under natural monopoly leads to low quality goods as well as out-dated services (Gronberg, Jansen, Karakaplan, Taylor, 2015). The government of each nation has been intervening in the market for natural monopoly from long time. Natural monopoly has been benefitting the nation by its properties of economies of scale. But there is market failure associated with this system (Krugman, Obstfeld, Melitz, 2015). As monopolists are the sole producer of the goods they always try to grab the maximum consumer surplus by keeping their price at very high level. Since at this price most of the people cannot afford to get the services and goods at that high price hence there occurs market failure and the government needs to intervene in this situation to enhance the situation. The monopoly market is characterized with allocative inefficiency. The situation where the average revenue of the firm and the marginal cost of the same get balanced or equated is known as allocative efficiency (Browning Zupan, 2014). It is the situation where the total consumers demand gets balanced by the total production in the economy. The objectives behind the government to intervene in the situation of natural monopoly are as follows: Reducing the dead-weight loss of the society and creating conditions to improve the welfare of the society as well. In other words it can be said that the government tries to maintain an efficiency and balance in the society by creating a situation that lies in between the two extreme situations of perfect competition, the utopian situation and the absolute monopoly (Miller, 2016). The diagram below is going to help in understanding the situation and the benefits of the government intervention. The diagram above shows that Ps is the competitive price of the market where the marginal cost curve and the demand curve intersects. Qs is the output under perfect competition. Under the situation of absolute monopoly, Pm is the price that is quite above the Ps. Qm is quantity of the monopoly market. As seen from the diagram the quantity produced is quite lower than the quantity that has been produced by the perfect competition. Now when the government intervenes the price is set at the point where the two curves namely the long run average total cost curve and the demand curve of the monopolist firm intersects. At this point the price is Pg that is in between the monopolist and perfect competition price. Also the quantity of the natural monopoly firm produced with the government intervention also increased to Qg from the original quantity Qm. Under certain situation the government has to take up the duty of providing certain services to the consumers in order to maintain and regula te the services and goods provided to the people (Minamihashi, (2012).). Some of the markets where natural monopoly exists are: market for railway services, defense industry and electricity service at certain times. The market of natural monopoly can be regulated by the government through three different channels (Nash, 2015). They are: Direct regulation: There are certain sectors in the economy which are strictly under the control of the government. The government of any nation usually does not allow any other private sector company to intervene in providing the services and goods due to some high cost and risk associated with it (Stigler Mencken, 2016). Say for example, the defense industry is usually controlled by the government of the respective nation. If this industry is given to the private sector to regulate then they may either charge extreme high cost for providing the service or it may affect the quality of the services provided by them. Price regulation: The system of price regulation is quite often taken into consideration for curbing the problems of the natural monopoly. Usually price regulation is a situation where the prices of goods and services are quoted by the higher authority specially the government of the country (Stiglitz, 2015). Prices can be quoted in two ways namely by price ceiling and price flooring. The price flooring is usually used to protect the exploitation carried on the workers by setting the minimum wages that the company must pay to its employees. In the market of natural monopoly the price ceiling is used. The government quotes the maximum price that the monopolist can charge. That price is usually quoted at the point of intersection between the demand curve and the average total cost curve. Quota or quantity regulation: Through the system of quota the government tries to regularize the quantity supplied in the natural monopoly market which would otherwise be not supplied (Weyl Fabinger, 2013). Quota is the minimum amount of goods and services that the company must or firms must produce in order to operate in the market. Here in the diagram if the government fixes the quota at Qg then automatically the prices gets reduced at Pg from Pm. Under this scenario if the monopolist argues and tries to keep the price at the Pm then there is going to be a huge surplus in the economy by the amount of (Qg-Qm). The resultant effect of the government intervention in this market is the reduction in the dead-weight loss. The present reduced dead-weight loss to the society is highlighted by the small triangle EFG. Conclusion The whole essay can be summed up by stating few facts once again. It is that the market for monopoly is associated with the severe problem of market failure. The utopian situation of perfect competition is the most desirable scenario from consumers perspective whereas from the producers viewpoint the monopoly is the best market. The government of the any country always intervenes in the natural monopoly market to provide a feasible outcome in the economy. A third option is left out with the government to improve the situation. It is the method of encouraging research and development in the economy. 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