A monopoly at its most basic level can be defined as the restricted management of a good or service in a specific market with a single business entity having the legal right to control the supply and price of that commodity. A monopoly can be considered as being “natural” when the fixed cost of providing the commodity cannot be handled by a second company since it is too high. Therefore, only a large-scale ownership of the rights of operation is profitable in the market, thereby leading to only one company having the ‘natural’ right to operate. This is usually the case where governments own rights to provide services such as water and electricity through parastatals.
Explain the advantages and disadvantages of regulating a natural monopoly through
(a) A marginal cost pricing rule
This is a method employed by regulators to restrict the prices set by businesses. The prices are set based on the marginal cost of the product. The major advantage to this is that it ensures an efficient utilization of recourses. Another advantage is that the market is able to get the commodity at a ‘reasonable’ price, which even though not ideal, is at least acceptable in the market. The disadvantage to this rule is that the businesses are bound to incur heavy losses rendering them not feasible in the end (Baumol & Blinder, 2008). Another disadvantage is that the chances of reducing the monopoly are raised multifold as the initial fixed cost of joining the market become to high.
(b) An average cost pricing rule
This is a method employed by regulators to put a check on the prices set by monopolies. The set price of the commodities is based on the costs that the monopolies incur in the production of the goods. The problem characterized by consumers being taken advantage of by monopolies is averted as these organizations find their commodities being traded at set prices that just meet the costs incurred during production and distribution. Another advantage is that it also keeps into consideration the costs incurred by the businesspersons to ensure that they do not incur any losses. A disadvantage to this is that is goes against the principles governing free market (Samuelson, 1980). Another disadvantage is that the potential profits that a second company would get from an entry into the industry are cut significantly thus making it almost impossible to end the monopoly.
What is a recessionary gap? How does the economy adjust to eliminate a recessionary gap?
A recessionary gap is an occurrence characterized by a nation’s economics being adversely affected by a low-employment balance. Under this condition, the gross domestic product in this country is usually more diminished than when the nation is under the level of full employment. This has the effect of making the prices of different commodities in the said nation to fall as a means of regaining the normal balance. The presence of a recessionary gap in any given financial system leads to elevated financial exchange charges that usually lower the foreign exchange gained after the country has sold its local products to outside countries. It is later followed by a recession and low investment by the consumers due to minimized due to poor take-home pay.
To eliminate recessionary gaps, a government may step in through implementing stabilization policies. These usually entail an increase in government expenditure while at the same time ensuring that the taxation rates are lowered. The overall effect is an increase in the aggregate demand thereby correcting the situation over time.
How can a higher price of oil create inflation?
In essence, higher prices of oil do not create inflation. This is because higher oil prices translate into higher prices in oil-based products such as gasoline that most individuals find necessary in their lives. Higher expenditure on such products further leads to a decrease in the amount of money available to spend on other products, hence driving the demand and prices for the ‘other products’ down. However, the higher prices of oil do not lead to an increase in the money supply – or inflation – as they do not mean that the people will have more money to deal with the raised oil prices (Libertarian Investments, 2011).
The dependency ratio, the proportion of people in the age group 0 to less than 15 years, plus the proportion of people in the age group 65+ years to the number of people in the age group 15 to less than 65 is rising.
(a) In terms of GDP per capita, why might this be a problem?
The GDP is a measure of all the goods and services produced by a given nation according to their market value. A rise in the dependency ration means that more strain is applied to the working class in trying to provide to the growing number of dependents. The rise in the dependency ratio negatively affects the GDP as more resources are aimed at providing for the needs of the dependants rather than growing the economy. The GDP per capita is obtained when the market value of all commodities that a country produced and measuring this against a denominator that comprises of the total number of its people. An increase in the dependency ratio means fewer persons are engaged in economic productive activities. The market value of all the products produced by these few when calculated and then divided by the total population, it results into a much-diminished figure. The increase also puts a strain on the government expenditure in terms of providing food infrastructure and health facilities for this group who do not necessarily contribute in terms of taxation to the governments fund (Nørgaard, 2000).
(b) Explain how changes in labor force participation may partially offset the fall in GDP per capita.
Labor force participation measures the ratio of a subsection of a given population, such as for women and older workers who can be considered as engaging in economic productive activities or who are searching for employment. The labor force participation rate can be obtained by seeking a ratio of all individuals of working age in a country who have gainful employment against those who are actively seeking employment opportunities. When there is an increase in the labor force participation, there is a fall in GDP per capita as the amount of products produced in a given country increase. The increment in the number of individuals engaging in economically productive activities results in a rise in demand for goods produced. This has the end effect of offsetting the fall in GDP per capita in the given country (Debroy, 1996).
Fig 1. Rise in GDP per capita due to Labor force Participation: Per capita GDP, in purchasing power parities (Nørgaard, 2000)
(c) In the absence of a rise in labor force participation or of an increase in the hours worked per worker, will we have to accept that GDP per capita will fall?
The absence enough labor force participation or a decrease in the hours worked per worker results into a fall in the GDP per capita. This is because the GDP per capital is a measure of the market value of the total amount of goods and services that a given person produces. It is also measured by calculating the total goods and services produced by a country and dividing it by the total population in the country. Decreasing the number of workers in a given nation will result in a decrease in the total goods and services that the nation usually produces. Labor participation means that more people engage in economic activities and assist in the generation and creation of goods and services. Decreasing the labor participation will imply that few individuals engage in economically productive activities thus leading to low production. Decreased hours worked per worker also results into a fall in the GDP per capital. The hours used in the production of goods and services are now spent in other activities. This results onto a fall in the total amount of products that a person produces (Debroy, 1996).
Baumol, W. J. & Blinder, A. S. (2008). Economics: Principles and Policy. Clifton Park, NY: Cengage Learning.
Debroy, D. (1996). The Sterling Dictionary of Economics. Rochester, VT: Sterling Publishers Pvt. Ltd.
Nørgaard, O. (2000). Economic institutions and democratic reform: a comparative analysis of post-communist countries. Chappaqua, NY: Edward Elgar Publishing.
O’Connor, D. E. & Faille, C. ( 2000). Basic economic principles: a guide for students. Westport, CT: Greenwood Publishing Group.
Samuelson, P. A. (1980). Economics. New York, NY: Tata McGraw-Hill Education.
Libertarian Investments. (2011, February 24). Do Higher Oil Prices Cause Inflation? Retrieved from http://libertarianinvestments.blogspot.com/2011/02/do-higher-oil-prices-cause-inflation.html