Monopoly Market Assignment Project

Running head: NATURAL MONOPOLY
Natural Monopoly
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1NATURAL MONOPOLY
Introduction
Monopoly is a market where single seller captures the entire market share. Because of
maximum market power the monopolist always, exploit resources. In a monopoly market
resource allocation and distribution is not done in an efficient manner. There is always a
deadweight loss in the resulting market. However, there are situation where presence of a single
business firm leads to economies of scale and hence, is best in terms of efficiency in allocation.
Such a market is called natural monopoly. It might happen that one firm is able to operate at the
decreasing part of average total cost and still satisfies market demand. This is the situation where
the production process entails a high fixed cost compared to the variable cost. This is described
as the situation of natural monopoly. Dividing natural monopoly market results in rising average
cost and hence a higher price in the market.
Mostly public utilities such as water service, electricity service are examples of natural
monopoly. Natural monopoly possesses a dilemma in public policy designing. Because of
presence of economies of scale, natural monopoly entails productive efficiency. If entry is
allowed in the market then consumers suffers with a high price. Being a sole supplier in the
market the monopoly might be tempted to exploit its monopoly power and earn a higher profit.
Therefore, such an unregulated monopoly causes concern.
Comparison between monopoly and perfect competition
In a perfectly competitive market, there are several sellers and buyers participating in the
exchange process. The equilibrium of a single firm occurs at a point where price equals marginal
cost in the short run and in the long run price is set at the minimum point of average total cost
leaving only normal profit for the firms presents in the industry (Lim & Yurukoglu, 2015). The

2NATURAL MONOPOLY
equilibrium in the industry is obtained at the point of intersection between the industry demand
and supply curve.
The situation is different in a monopoly market. There are no difference between firm
and industry in a monopoly market. The industry supply curve becomes marginal cost curve for
the monopolist. The monopolist set it price where marginal revenue equals marginal cost. The
resulted price and quantity in the monopoly market is inefficient in comparison to the
competitive market. It is seen that the monopolist sells a lower quantity at a high price as
compared to competitive firm (Stiglitz & Rosengard, 2015). This results in loss of welfare to the
society known as deadweight loss. This is explained in the following figure.
Figure 1: Monopoly and competitive market
(Source: As created by Author)

3NATURAL MONOPOLY
Natural Monopoly
As discussed above existence of monopoly in a pure form is a inefficient form of market.
The situation in natural monopoly is quite different. There are markets where allowing
competition is not an optimal decision. Public utilities are examples of natural monopoly.
Natural monopoly operates at the falling part of average total cost. Because of operating at the
left of minimum point of average cost natural monopolists reap the benefit of economies of
scales (Lim & Yurukoglu, 2014). However, the pricing strategy here leads to ambiguity. Three
types of pricing strategy can be observed in a natural monopoly market.
Pricing in natural monopoly market
Figure 2: Different pricing point in natural monopoly
(Source: as created by the author)