A function of government is to regulate “natural monopolies.” Explain

A function of government is to regulate “natural monopolies.” Explain what is a natural monopoly and why it requires government regulation.

What will be an ideal response?

ANSWER

Natural monopolies occur when there are large cost economies of scale such that one producer can operate in the declining range of average cost while meeting the entire market demand for a product. In these situations it is more economical to have only one producer of the product, since production costs will be lower and the product can be profitably sold at lower prices than if there were several or more producers. Thus, the economy would benefit from having only one producer, but this would permit the producer to earn monopoly profits from lack of competition. Therefore, government should permit only one producer but regulate its operations, including selling prices, so that it doesn’t exploit its monopoly position.