Natural Monopoly

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A Natural Monopoly is a Monopoly whose long-run average cost would increase if it were a Competitive Market.



  • (Wikipedia, 2014) ⇒ Retrieved:2014-8-2.
    • A natural monopoly is a monopoly in an industry in which it is most efficient (involving the lowest long-run average cost) for production to be concentrated in a single firm. This market situation gives the largest supplier in an industry, often the first supplier in a market, an overwhelming cost advantage over other actual and potential competitors, so a natural monopoly situation generally leads to an actual monopoly. This tends to be the case in industries where capital costs predominate, creating economies of scale that are large in relation to the size of the market, and hence creating high barriers to entry; examples include public utilities such as water services and electricity. [1] While in other situations a monopoly can lead to restricted output, higher-than-necessary prices, and production that is inefficient (at higher average cost) than would occur with many producers, a firm that is a natural monopoly produces at lower average cost than would be possible with multiple firms. This frees other potential competitors to put their resources to other profitable uses. [2]

      Multiple product industries tend to create a negative externality that could otherwise be avoided if a Natural Monopoly producer were present. The reasoning is that natural monopolies provide a greater overall benefit to society versus a competitive market.

  1. Perloff, J, 2012. Microeconomics, Pearson Education, England, p. 394.
  2. Competitive Enterprise Institute. The Problem with Predation. webpage. 4/22/14

  • (Wikipedia, 2014) ⇒ Retrieved:2014-8-2.
    • A natural monopoly is a company that experiences increasing returns to scale over the relevant range of output and relatively high fixed costs.[1] A natural monopoly occurs where the average cost of production "declines throughout the relevant range of product demand". The relevant range of product demand is where the average cost curve is below the demand curve.[2] When this situation occurs, it is always cheaper for one large company to supply the market than multiple smaller companies; in fact, absent government intervention in such markets, will naturally evolve into a monopoly. An early market entrant that takes advantage of the cost structure and can expand rapidly can exclude smaller companies from entering and can drive or buy out other companies. A natural monopoly suffers from the same inefficiencies as any other monopoly. Left to its own devices, a profit-seeking natural monopoly will produce where marginal revenue equals marginal costs. Regulation of natural monopolies is problematic.[citation needed] Fragmenting such monopolies is by definition inefficient. The most frequently used methods dealing with natural monopolies are government regulations and public ownership. Government regulation generally consists of regulatory commissions charged with the principal duty of setting prices.[3]

      To reduce prices and increase output, regulators often use average cost pricing. By average cost pricing, the price and quantity are determined by the intersection of the average cost curve and the demand curve.[4] This pricing scheme eliminates any positive economic profits since price equals average cost. Average-cost pricing is not perfect. Regulators must estimate average costs. Companies have a reduced incentive to lower costs. Regulation of this type has not been limited to natural monopolies.[4] Average-cost pricing does also have some disadvantages. By setting price equal to the intersection of the demand curve and the average total cost curve, the firm's output is allocatively inefficient as the price exceeds the marginal cost (which is the output quantity for a perfectly competitive and allocatively efficient market).

  1. Binger and Hoffman (1998), p. 406.
  2. Samuelson, P. & Nordhaus, W.: Microeconomics, 17th ed. McGraw-Hill 2001
  3. Samuelson, W; Marks, S (2005). Managerial Economics (4th ed. ed.). Wiley. p. 376. 
  4. 4.0 4.1 Samuelson and Marks (2003), p. 100.