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Natural Monopoly

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Daniel Haynes

on 21 November 2013

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Transcript of Natural Monopoly

Natural Monopoly
Natural Monopoly,
The Basics

Natural Monopoly is where a monopolist has overwhelming cost advantage; a market where long-run average costs are lowest when output is produced by one firm.

A good example of a natural monopoly is the National Rail, the ‘company’ that owns, maintains and leases out the UK rail network, this is a natural monopoly, not the franchises which run the trains. It is a natural monopoly, and will remain to be so, due to it being a service which is best done by one firm.
Cause of Natural Monopoly
A natural monopoly can be formed if a monopoly has sole ownership of a resource, or where past ownership of capital resources makes it extremely expensive for new competitors to enter the market. In addition, it would also be extremely wasteful to do this.
The Natural Monopoly Graph
The key point is that a natural monopoly is characterized by increasing returns to scale at all levels of output – thus the long run cost per unit (LRAC) will drift lower as production expands. LRAC is falling because long run marginal cost is below LRAC. This can be illustrated in the top diagram.
The profit-maximizing price is P1 at an output of Q1. Price is well above the marginal cost of
supply and high supernormal profits are made – but output is high too and there is still a sizeable
amount of consumer surplus because of the internal economies of scale that have brought down
the unit cost for all consumers.
Advantages and Disadvantages of Natural Monopoly
Also, they could occur when there is not enough demand for more than one company to full exploit external economies of scale, and therefore one company has an overwhelming cost advantage
One advantage of a natural monopoly is that it can save resources, as it would be impractical if more than one business actually provided the service, leading to a reduction in the amount of resources the industry uses.
Another advantage of a natural monopoly is that, as output increases, average costs will fall, offering the prospect of substantial benefits to be gained from economies of scale as costs will get spread out more over a larger amount of output due to the relatively small marginal cost and high fixed costs.
A disadvantage of a natural monopoly is that it allows the firm to set its prices, and due to the monopolistic nature of the firm, they don't have to compete with other firms, leading to possible market failure in terms of being efficient.
Another disadvantage is that in a natural monopoly, they have no incentive to invest in new products or research and development, which even though customers may get frustrated, there is no alternative.

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Full transcript