Regulated monopoly

Because unregulated monopolies seek to maximize profits, output is restricted so that price is set higher than what everyone can afford. However, some monopolies control products or services that are considered basic neccesities for human survival. In order to get companies to produce enough of a product for everyone, governments regulate a firm's output.

Socially optimal price (which is also allocative effiency): P=MC:

· To achieve allocative efficiency, a firm should produce so that P=MC. In order to simulate allocative efficiency in a pure monopoly, governments set a price ceiling which causes the monopolist's demand curve to become horizontal (meaning that it becomes perfectly elastic). The monopoly is then forced to produce at P = MC = MR, and attempt to minimize losses (or maximize profits).

· Sometimes this price ceiling is set so low that it does not cover the Average Total Costs of production, and companies become bankrupt in the long run. In order to remedy this, governments set a fair return price.

Fair-return price: P=ATC:

· Regulations to price so that monopolies do not become bankrupt. Economics profit is equal to 0, so normal profits are covered.

· Utility owners get a "fair return" where P=ATC

Dilemma of regulation:

· When a regulated monopolies price is set to achieve the most efficient allocation of resources (P = MC), the regulated monopoly is likely to suffer losses, or economic losses, while only making normal profits.

· Survival of the firm would presumably depend on permanent public subsidies out of tax revenues, or subsidies to the firm via the government.

· Although a fair return price (P = ATC) allows the monopolist to cover costs, it only partially resolves the underallocation of resources that the unregulated monopoly price would foster, thus the monopoly is still deemed inefficient.

· The fair return price does not achieve socially optimal output:

ü Despite this, the price regulation is positive from a social point of view because:

ü It reduces price, increases output, and reduces the economic profits of monopolies.

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