The structure of a business and its conduct in the industry are influenced by government regulations. Price regulation also has an impact on the business’s profitability.
This statement describes how to price regulations affect business practices. Regulations ensure that prices are fair and businesses don’t establish monopolies. This is the primary purpose of regulations. They will allow companies to set their prices without restrictions.
Government regulation has been criticized by many sectors of the business community. Many corporations and their representatives often complain about government regulations as impediments to profit, economic efficiency and job creation. Many firms used loopholes to move operations overseas and have violated antitrust law while trying to comply with regulations.
Today, most true monopolies in the United States are natural, regulated monopolies. Natural monopolies challenge competition policy because of how costs and demand structure make competition difficult or prohibitive. A Natural monopoly happens when average costs decrease over the product range that meets market demand. Fixed costs are often higher than variable costs. This means that one firm can supply the entire market with the same quantity at a lower price than other firms. Therefore, splitting up the natural monopoly could increase the average cost of production while forcing customers to pay more.
Congress passed the antitrust legislation in 1890. It then continued with changes in corporate tax rates and more complex regulations governing business. 1. The business community generally opposes laws, regulations, and tax levies that hinder its operations or profitability. Over regulation and excessive taxation are often criticized because they create a net cost for society over the long term. Critics claim that government regulations slow disruptive innovation and don’t adapt to social changes.
Cost-Plus versus Price Cap Regulation
For many decades, regulators of public utilities followed a general approach that tried to pick a point similar to F in Figure 1. They took the average cost of production of the electricity and water companies and added a percentage of the expected profit. The price they set for consumers was then determined. This was cost-plus.
Cost-plus regulations can create problems of their own. Producers will be reimbursed for their costs plus some more. This means that producers don’t have to worry about high costs. They can simply pass them on at higher prices. Even worse, cost-plus regulations incentivize firms to create high costs by building large factories and employing many people. The costs they incur determine what they can charge.
Summary and Key Concepts
If there is a natural monopoly, market competition will not work well. Therefore, instead of allowing an unregulated monopoly to increase the price and decrease output, the government might want to regulate price/output. Public utilities are regulated companies that provide water and electricity.
Cost-plus regulation is government regulation of a company that sets the price a firm can change over time. This is done by considering the firm’s accounting expenses and adding an average profit rate. Price cap regulation is government regulation where the government sets a price level for firm several years ahead. The firm can make high profits if they manage to produce at lower prices or sell more than expected. However, it may also suffer losses or profits if its costs are high or it sells fewer than expected.