HI 5003-Economics| Natural Monopoly

ECONOMICS
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Natural Monopoly – Definition and Causes
Natural monopoly refers to a situation when a single firm is in a better position to serve the
market in comparison with two or more firms. Typically in a natural monopoly due to the
significant cost advantage that is enjoyed by the existing player, the other players have no
chance with regards to entering the market (Samuelson & Marks, 2003). There are various
reasons which can give rise to a natural monopoly. One of these is economies of scale which
essentially refers to a situation where there is a decrease in the overall cost as the production
output increases. As a result, the existing firm owing to the large output tends to have a cost
advantage which a new entrant would not be able to match and this acts as a natural entry
barrier against any competition (Mankiw, 2014). Another key reason contributing to a natural
monopoly is in the form of control over scarcely available resources. This may be in the form
of network or existing infrastructure which related to railway lines, transmission lines of
telephone etc. Thus, the player which has control over the above resources tends to act as the
sole supplier and the new firms cannot enter the market without the same resource. Further,
another reason for existence of natural monopolies is in the form of government intervention
and policies. This is typically the case in various industries where the upfront costs are
exceptionally high such as electricity transmission, gas pipeline etc. In such cases, it makes
sense not to cause duplication of this immense infrastructure and thereby confining the
market to only one player makes sense (Nicholson & Snyder, 2011).
Natural Monopoly – Determination of Price and Quantity
The monopolistic firm would tend to take economic decisions with the objective of
maximising profit. As a result the firm tends to produce till the price is greater than the
marginal cost. This would lead to the available resources being under-allocated. This is
because the corresponding output is lower than the comparable output expected in perfect
competition while the price charged is significantly higher. The equilibrium for the
monopolistic firm is indicated below (Besanko & Braeutigam, 2010).
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The corresponding quantity produced by a monopolist firm is indicated by Qm while the price
charged by the firm is indicated by Pm. It is noteworthy that the firm tends to produce at a
level where the AC or Average cost is not at its lowest point. Hence, in order to maximise
efficiency ideally, the firm should produce at a point where the AC is at the lowest point.
However, increasing the production and corresponding lowering the price would not enable
the firm to maximise profits (Krugman & Wells, 2008). Thus, a firm in the natural monopoly
tends to under-produce as the efficient output level would be higher. Additionally, if
theoretically some competitor does try to entry to market, the monopolist firm can enter the
production quantity thus lowering the cost further and reducing the price, thereby ensuring
that the competitor would have to quit the market (Mankiw & Taylor, 2011).
Natural Monopoly – Efficiency
Considering that resources are scarce, it is essentially that these should be allocated and
utilised in a manner so that the productive and allocative efficiency is maximised. This does
not happen in case of natural monopoly especially if there is no intervention from the
government. The analysis of the efficiency in monopoly can be reflected in the diagram
indicated below (Nicholson & Snyder, 2011).
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