Natural monopoly is a unique sub-branch of monopoly theory.
It involves market structures with specific characteristics, particularly in utility sectors.
Real-Life Examples of Natural Monopoly Markets
Utilities:
Water distribution
Gas and electricity distribution
Internet distribution
Infrastructure Providers:
Rail track providers
Characteristics of Natural Monopoly Markets
High Fixed Costs:
Significant startup costs associated with infrastructure.
Examples:
Rail track infrastructure
Water pipeline systems
Internet and gas/electricity distribution
Economies of Scale:
High fixed costs lead to potential for economies of scale.
Long-run average cost curve is downward sloping across a wide quantity range:
Minimum efficient scale occurs at a very high quantity.
Market Structure:
Only one firm typically serves the entire market.
Competition is often undesirable due to:
Wasteful duplication of resources
Allocative inefficiency
First mover advantage gives economies of scale to the initial firm, pricing out later entrants.
Impacts of Competition vs. Natural Monopoly
Competition:
Leads to allocative inefficiency and productive inefficiency.
Natural Monopoly:
Single firm can achieve allocative efficiency and productive efficiency when regulated.
Cost and Revenue Curves in Natural Monopoly
Revenue curves (average revenue and marginal revenue) are typical for monopolists.
Profit Maximization:
Occurs where marginal revenue equals marginal cost.
Results in supernormal profit when average revenue exceeds average cost.
Regulatory Considerations
High prices and low quantities in natural monopolies often lead regulators to intervene:
Allocative Efficiency:
Regulators aim to set prices at P* and quantities at Q*.
However, regulation can lead to subnormal profits for the monopolist:
Average cost may exceed average revenue at regulated levels.
Potential for large areas of subnormal profit.
Solutions for Sustaining Natural Monopolies
To address losses, regulators may provide subsidies:
Subsidies help cover losses to ensure continued production.
Example:
Subsidy equal to the loss per unit can be implemented.
Many natural monopolies are state-run to avoid complications of private monopolies.
In cases of private natural monopolies, significant regulation and subsidies are often necessary.
Conclusion
Understanding natural monopolies reveals that one regulated firm can lead to allocative and productive efficiency, while competition can lead to inefficiencies.
Important implications for the regulation of essential services in society.