Price regulation can be defined and stated as the Government supervision or control that government implies directly on the prices of goods and commodities in a specific market. Commonly we say that, price regulation is the policy which aids different government institutions, legal statutes or regulatory authorities in fixing prices. With the use of this policy, a floor price which is the minimum price and / or a ceiling price that is the maximum price can be stated by the government or legal bodies. Not only balancing the prices, but price regulation also deals with the specific rules and regulations which settle on the amount through which prices can be decreased or increased same as the situation of rent controls. Commonly, the factors which assist in selecting the regulated prices tend to be different from condition to condition. These factors can be costs, markup, return on investment, etc.
Why Price Regulation?
Price regulation is utilized in many situations but it is vastly useful for the markets that are monopolistic or natural monopoly. A market fails to attain efficiency and effectiveness in terms of allocation and production when the industry general structure is natural monopoly.
Three cost curves (marginal cost, average total cost and marginal revenue) overlaid.
To explain the situation, let’s take Figure 1. The figure exhibits a natural monopoly that arises from economies of scale of production for the company which sells a specific product. As it can be seen that the average total cost curve (ATC) is declining at every point (Consequently the marginal cost curve, MC, lies below the average total cost curve completely). Hence we can say that industry as a natural monopoly. Then presume that this company in conversation (and regulator) is able to demand only a given cost. This way we can presume that price discrimination in this particular example is void. In deficiency of appropriate price regulation through the authorities, the company will likely to make the most of profits by making equal marginal cost and marginal revenue. This will make the price PM and quantity developed QM. In this condition, to obtain productive efficiency, it is necessary to develop at the lowest point of the average total cost curve. It can be seen that the market result breaks this situation. To attain allocative efficiency it is required that production occurs when the marginal cost curve intersects the demand curve. It can be observed from the figure again that the market outcome does not convince this condition. Implicit to the social optimum, as we can easily see here that social welfare is decreased through the areas A, B, C and D. This area is defined as the deadweight loss in this situation and it is not a liking situation. To avoid this situation price regulation is done by the government.
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