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Federal and Regional Financial Relations Prof. Dr. André W. Heinemann Business Studies & Economics
Chapter 5
Network Infrastructures, Natural Monopolies, and
Regulation
5.1 Monopoly
What Is a Monopoly?
A monopolist is a firm that is the only producer of a good that has no close
substitutes.
A monopolist has market power, and market power is the ability to raise prices.
A monopolist reduces the quantity supplied and moves up the demand curve,
raising the price.
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5.1 Monopoly
Why Do Monopolies Exist?
For a profitable monopoly to persist, something must keep others from going
into the same business, that „something“ is known as a barrier to entry.
Technological Superiority
Government-Created Barrier
Network Externality
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5.2 Natural Monopoly
What Is a Natural Monopoly?
In some cases, the public sector produces some private goods and services
• Examples:
Rail-based urban mass transportation, public water supply, urban electricity grids etc.
• Main argument for public sector production:
Efficiency enhancement
Caused by
- High fixed costs related to low variable costs
- Economies of scale (increasing returns to scale), subadditivity
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5.2 Natural Monopoly
Reasons for Natural Monopolies
Subadditivity
Decreasing
Average Cost
Economies of Scale
Source: Fritsch, Michael (2014), Marktversagen und Wirtschaftspolitik. 9., vollständig überarbeitete Aufl., Vahlen, München, p. 167.
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5.2 Natural Monopoly
Marginal Cost, Average Cost and Natural Monopoly
𝑃
𝐴𝐶: Average Cost
𝑀𝐶: Marginal Cost
𝑀𝑅: Marginal Revenue
𝑃: Price
𝑋: Output
𝐷𝑋
𝐵
𝑃 𝐴𝐶 𝐴𝐶
𝑃∗ 𝑀𝐶
𝐴
𝑋∗ 𝑋
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5.2 Natural Monopoly
Natural Monopoly and Deadweight Loss
𝑃
𝐴𝐶: Average Cost
𝑀𝐶: Marginal Cost
𝑀𝑅: Marginal Revenue
𝑃: Price
𝑋: Output
𝐷𝑋
𝐶
𝑃𝐶
𝐹 𝐵
𝐴𝐶
𝑃∗ 𝑀𝐶
𝐸 𝐴
𝑋𝐶 𝑋𝐹 𝑋∗ 𝑋
𝑀𝑅
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5.2 Natural Monopoly
Unregulated Monopolist
Monopoly profit are equal to the product of number of units sold times the profit per
unit.
Inefficiency!
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5.3 Public Sector Production
Goals of Public Sector Production
Public sector produces 𝑋 and provide to the point where price equals marginal cost 𝑀𝐶.
Losses can be financed by taxes.
Public sector produces 𝑋 and provide to the point where price equals average cost 𝐴𝐶.
Neither profits nor losses
Average cost pricing leads to more output than at the profit-maximizing level, it still falls
short of the efficient amount.
Ramsey solution
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5.3 Public Sector Production
Average Cost Pricing
𝑃
𝐴𝐶: Average Cost
𝑀𝐶: Marginal Cost
𝑀𝑅: Marginal Revenue
𝑃: Price
𝑋: Output
𝐷𝑋
𝐹 𝐵
𝑃 𝐴𝐶
𝐴𝐶
𝑃∗ 𝑀𝐶
𝐴
𝑋𝐹 𝑋∗ 𝑋
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5.3 Public Sector Production
Problems of Public Production
Public ownership means the government establishes a public agency to provide the good
and protect consumers´ interests.
Sometimes publicly owned companies are less eager than private companies to keep
costs down or offer high-quality products.
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5.4 Limits of Natural Monopolies
𝑃 𝐷2
𝐷1
𝐴𝐶
𝐵
𝐵
𝑃
𝐴
𝑃𝐴
𝑋𝐴 𝑋𝐵 𝑋
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