a. Explain why a government might want to regulate a monopolist? (1 mark) b. What is cost padding? (2 marks) c. How does cost padding affect the way governments might regulate a natural monopoly? (3...

1. Explain why a government might want to regulate a monopolist?
A monopoly is a type of market characterized by only one seller and/or producer. It is, in a way,
an extreme case of capitalism where no competition exists. This often results in overpricing of
products or inferior quality. Either way, it is not a favorable situation for the consumer.
The motive of any government intervention or regulation is and must always be welfare of its
citizens. That’s exactly the case with Government regulation in monopolies as well. Without
government regulation, a monopolist can price its product above, leading to allocative
inefficiency.
Secondly, such a firm would have little incentive to offer a good quality product. Government
egulation aims at ensuring that the firm meets at least a minimum standard of quality.
Also, a firm with monopoly selling power may also try and put itself in a position to exploit
monopsony power in dealing with vendors. For instance, supermarkets could use their strong
market position to exploit suppliers off their profits. Walmart which is notorious for extracting
monstrous discounts from suppliers and giving lower than minimum wages to its employees
can be an excellent example of it.
Given the following arguments, it’s necessary for governments to regulate industries where
there is natural monopoly. A natural monopoly situation usually arises when there are large
fixed costs and small marginal costs.1 These industries are typically capital-intensive and require
significant investments in long-lived, sunk capital facilities. Most assets are specific and durable,
giving rise to high-entry ba
iers via extensive sunk costs. Network industries such as railways
and electricity distribution are perfect examples of such monopolies. The existence of a natural
monopoly gives rise to the following problem: Allowing monopolist to set the monopoly price is
undesirable due to the Pareto inefficiency, and forcing the natural monopoly to sell at the
efficient price (i.e., marginal cost based price) is infeasible due to negative profits.
One of the solutions is to let government operate such services, but this experience shows has
other issues relating to operational efficiencies and the argument that the government has no
usiness to be in business. This leads to the solution that private operators are allowed to run
monopolies but with significant government regulations.
The idea behind regulation is to improve the efficiencies of the market while at the same time
control the rent seeking behavior of firms controlling the monopolies. But such Regulation may
lead to certain undesired or harmful side-effects. One of them being Cost Padding, which is any
type of accounting contrivances by the monopolist to increase his cost structure and hence the
emuneration receipts from the regulator. Another argument is that while regulations if
implemented properly, which itself is a highly debated area, lead to improvements in static
efficiencies but it’s impact on productivity and growth aren’t taken into consideration. Another
argument is that dynamic efficiencies like R&D and innovation take a hit due to regulation.
Also, such regulations may reduce the monopolists’ incentive to invest in cost reduction, which
leads to inefficiency in production, the cost of which is born by the government. This ro
ing of
public money poses a serious threat for regulators.
2. What is cost padding?
Cost padding simply put is unnecessary...