Natural Monopoly

• Natural monopoly

  A submerge of monopoly theory, a brilliant market structure to investigate and analyze
• Natural monopoly markets

  • Utilities (water distribution, gas, electricity distribution, internet distribution)
  • Rail track providers
• Characteristics of a natural monopoly market

  • Huge fixed costs, especially startup costs
  • Huge potential for economies of scale
• The long-run average cost curve for a natural monopolist is downward sloping for a huge quantity range
• Diseconomies of scale

  Occur at very high quantity levels, impossible to see on the diagram
• Competition is undesirable in a natural monopoly market
• Reasons why competition is undesirable


  It would result in wasteful duplication of resources<|>It would not allow for the full exploitation of economies of scale, leading to productive inefficiency
• A natural monopoly with one firm dominating the market would result in allocated efficiency and productive efficiency, if regulated
• Determining the profit-maximizing output and price for a natural monopolist

  1. Draw downward sloping cost curves

  2. Draw downward sloping demand and marginal revenue curves

  3. Produce where marginal revenue equals marginal cost

  4. Calculate supernormal profit as the difference between average revenue and average cost
• Regulators intervene in natural monopoly markets to set prices and quantities at the allocated efficient level
• When regulators set prices and quantities at the allocated efficient level


  The natural monopolist makes a loss
• Subsidy

  Given by the regulator to the natural monopolist to cover the loss and allow them to make normal profit
• Many natural monopoly industries have state-run natural monopolies instead of private ones, to avoid the need for subsidies