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ACCA Applied Knowledge · Business and Technology · Political and legal factors affecting business

A utility company is the only provider of water services in a region because duplicating the pipe network would be hugely wasteful. Which approach to controlling its market power is most appropriate?

The most appropriate approach is to allow the firm to operate as a natural monopoly while regulating its prices and service standards. A single network is the most efficient, so breaking it up would duplicate costs, while regulation protects customers from abuse of market power.

  1. ABreak it into many small competing firms, each building its own pipe network
  2. BAllow it to operate as a natural monopoly but regulate its prices and service standardsCorrect
  3. CBan it from charging any price above its average cost of zero profit in all circumstances

Explanation

Where very high fixed infrastructure costs make a single provider most efficient, a natural monopoly exists. Regulation, such as price caps and service standards, protects customers while keeping the efficiency. Breaking it up would duplicate costs, and a blanket zero-profit rule is not a standard or workable approach.

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