K is the amount of investment that the water firm needs to implement. In water, the price cap system is RPI -/+ K. In the early years of telecom regulation, the level of X was quite high because efficiency savings enabled big price cuts. If the regulator thinks a firm can make efficiency savings and is charging too much to consumers, it can set a high level of X. Then firms can increase actual nominal prices by 3-1 = 2%.X is the amount by which they have to cut prices by in real terms.Therefore, we cannot encourage competition, and it is essential to regulate the firm to prevent the abuse of monopoly power.įor many newly privatised industries, such as water, electricity and gas, the government created regulatory bodies such as:Īmongst their functions, they are able to limit price increases. Some industries are natural monopolies – due to high economies of scale, the most efficient number of firms is one. In some industries, it is possible to encourage competition, and therefore there will be less need for government regulation. For example, supermarkets may use their dominant market position to squeeze profit margins of farmers. A firm with monopoly selling power may also be in a position to exploit monopsony buying power. Government regulation can ensure the firm meets minimum standards of service. If a firm has a monopoly over the provision of a particular service, it may have little incentive to offer a good quality service. This would lead to allocative inefficiency and a decline in consumer welfare. Without government regulation, monopolies could put prices above the competitive equilibrium. Nationalisation – government ownership.Investigations into cartels and unfair practises.Price capping – limiting price increases.The government can regulate monopolies through: For example, monopolies have the market power to set prices higher than in competitive markets.
The government may wish to regulate monopolies to protect the interests of consumers.
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