15- Natural Monopoly

Question 1

What is a natural monopoly?

Answer 1

A natural monopoly occurs when the most efficient number of firms in the industry is one.

A natural monopoly will typically have very high fixed costs meaning that it is impractical to have more than one firm producing the good.

Question 2

Characteristics of natural monopoly?

Answer 2

• Huge fixed costs
• Enormous potential for economies of scale
• Rational for one firm to supply the entire market.

Question 3

Why is it rational for one firm to supply the entire market?

Answer 3

• Competition is undesirable as it would lead to a wasteful duplication of resources and non exploitation of full economies of scale- allocative and productive inefficiency.

Question 4

Efficiency in a natural monopoly?

Answer 4

Productive and allocative if the natural monopoly is regulated.

Question 5

Examples of natural monopolies?

Answer 5

• Rail network
• Utilities
• Water works
• Gas and electricity
• Telecommunications

Question 6

Assumption of goal of natural monopoly?

Answer 6

Profit maximisation MC=MR

Question 7

Why do regulators intervene?

Answer 7

• As when MC=MR there are high prices and low output.

- There is only one supplier of usually a necessity good e.g. gas so make natural monopoly produce where P=MC.

Question 8

Subsidy given to natural monopolists?

Answer 8

• When natural monopolists’ are forced to produce at P=MC, they make subnormal profits so the regulators give subsidies to cover loss per unit to make normal profits.

Question 9

Why are natural monopoly cost curves downwards sloping?

Answer 9

Because the cost of satisfying one more customer is less than the cost of the last customer due to high fixed costs and large potential for economies of scale.

Question 10

Costs in a natural monopoly?

Answer 10

• High fixed costs

- Low marginal cost

Question 11

Economies of scale

Answer 11

• An internal economy of scale is achieved as the total average cost will fall as more users are added to the network.
• Only one firm may reach minimum efficient scale.

Question 12

Benefits of natural monopoly on consumers?

Answer 12

• Gains in productive efficiency with large scale production
• Regulator may cap prices to help achieve allocative efficiency and help poorer families.
• Some of the supply chain to final consumers may be deregulated to stimulate competition thus lower prices.

Question 13

Cons of natural monopolies for consumers?

Answer 13

• In theory they could set very high prices.

- If MC