PRESENTED BYLAKHAN S. MEENA

K.RAMANMANISH HAIRATM.VIJAYA KUMAR

-A Case Study of Indian Railways

Need for Regulati on

of a Natural Monopoly

What is a monopoly?• A firm is considered a monopoly if . . .–It is the sole seller of its product–Product has no close substitutes

Monopoly - Introducti on

• Barriers to entry• Legal/Government Restrictions• Advantage of economy of scale• High cost of entry

Why do Monopolies Arise?

• A condition, created by circumstances- not by law• The largest supplier in an industry, often the first

supplier in a market, having cost advantage over potential competitors

• Fixed costs dominate. Creating economies of scale that are large in relation to size of market

• When fixed cost dominates, large customer base is required to achieve profit

• Therefore, new entrants are deterred from entering the market

Natural Monopoly

ATC

AVC

MC

D=MB

MR

Q

P

Pm

Qm

Ppc

Qpc

Monopoly

MR=MC

MC=MB

ATCAVC

MC

D=MB

MR

Q

P

Pm

Qm

Ppc

Qpc

Total Revenue

Total Profit

Total Cost

Monopoly

ATCAVC

MC

D=MB

MR

Q

P

Pm

Qm

Ppc

Qpc

Monopoly

ATC

AVC

MC

D=MB

MR

Ppass

Qpass

Pm

P

Q

TOTAL REVENUETOTAL COST

TOTAL LOSS

IR-Passenger Service

P<AVC

ATC

AVC

MC

D=MB

MR

P

QQm’

Pm’

Ppc

Qpc

TOTAL REVENUETOTAL COST

TOTAL PROFIT

IR-Freight ServicePm’<Pm

TOTAL REVENUE

ATC

AVC

MC

D=MB

MR

P

QQm’

Pm’

Ppc

QpcQr

Pr

TOTAL COST

TOTAL PROFIT

IR-Aft er Regulati onMin of

ATC

11

• The Regulator digs deep into the operations of a business and takes some of the firm’s decisions under its own control

• Regulators want to achieve economic efficiency, which they do by telling the firm what price it can charge

Regulati on of Natural Monopoly

12

Quantity

Price

D

MRAC

MC

C1

P1

Q1

An unregulated monopoly will maximize profit at Q1 and P1

MC2

P2

Q2

•Regulator will not allow the monopoly to charge P1 , its profit-maximizing price.

Unregulated Price

•Ideally Regulator would like monopoly to charge P2 , where P2 = AC (break –even point)

Regulated Price

Regulati on of Monopoly – Opti on 1

13

Quantity

Price

D

MRAC

MC

C1

P1

Q1

P2

Q2

Unregulated Price •Regulator may like monopoly to charge P2 , where P2 = MC, and this would generate a loss to the monopoly, as P2 < AC2

Regulated Price

AC2

•The monopoly would need a subsidy in this case equal to (AC2 – P2 )

Regulati on of Monopoly – Opti on 2

14

• Similarly if regulator wishes to achieve production efficiency (P = minimum AC), here too the monopoly operates at a loss and would need a subsidy

Regulati on of Monopoly

15

• The regulator may allow the monopoly firm to charge in between the two extreme cases, and the monopoly firm can increase profits by cutting costs

• With price regulation, the monopolist produces more, at a lower price

Regulati on of Monopoly

16

Ideally, the monopolist will continue this way until and sells at price = MC to the last group / for the remaining quantity

Q1

P1

The first group - Pays P1

Q2

P2 The second group - Pays P2

Quantity

Price

D

Under perfect price discrimination, the monopolist charges a different price to different buyers

MC

Price Discriminati on

17

• A monopoly may be able to increase its profits further through price discrimination – charging different prices to different categories of buyers

Price Discriminati on

18

The profits on the sales to high-price customers are enough to cover the losses on the sales to low-price customers

Quantity

Price

D

ACMC

Suppose that the Regulator allows the monopoly to charge a price of P1 to some users ( Premium service to premium class)

P1

Q1

C1

Other users are offered the lower price of P2 (Basic service such as Second class & Sleeper class travel)

P2

Q2

C2

Regulati on of Monopoly- Opti on 3

19

• Another approach is to allow the monopoly to charge a price above marginal cost that is sufficient to earn a “fair” rate of return on investment

Regulati on of Monopoly- Opti on 4

Consumer Surplus is Increased by Regulati on

• In any event, success or failure, government regulation has significant costs:–Collecting information on demand and costs–Creating and staffing bureaucracies to

administer and ensure compliance with the regulations–Regulated firms also have huge compliance

costs

Costs of Regulati on

Thank You