Page 65 - Azerbaijan State University of Economics

THE JOURNAL OF ECONOMIC SCIENCES: THEORY AND PRACTICE

products. Thus it is not easy to conclude confidently that prices charged for

particular products are excessive and should be reduced.
There is another, serious risk with regulating prices. In a market

economy profits serve a critical function: when firms earn high profits, they

create an incentive for others to enter the industry. When firms earn
relatively low profits, they have an incentive to exit. By responding in this

way, firms are more likely to produce goods and services that are highly
valued by consumers - efficient and good for consumers and firms. This

process requires that prices for the most part be unregulated. When
government agencies regulate prices, the crucial role played by profits in

providing incentives to enter and exit does not work well.

Of course, some firms cannot or do not enter markets even when
profits are high. This is often the case in industries in which firms have been

granted a legal monopoly by the government, as in most public utilities.

However, many other sectors of the economy may be heavily regulated,
making it difficult for a new and more efficient firm to enter the market.

Thus an important role for a competition agency can be to advocate removal
of legal barriers to entry. Competition agencies can provide recommen-

dations to legislative bodies and other government agencies on how laws and
regulations can be modified to strengthen competition and improve

efficiency.

There are, however, some industries in which the market can support
only one firm even when there are no legal barriers to entry. These natural

monopolies can arise when economies of scale or economies of scope (or
both) are so strong that the costs of production are lowest when a single firm

supplies the market. Examples may include electricity transmission and local
water supply. In Western economies the prices and practices of natural

monopolies are often not under the jurisdiction of the competition agency but

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