9) Natural Monopoly

Question 1

define natural monopoly

Answer 1

monopoly that arises in an industry in which there are such substantial economies of scale that only one firm is viable

Question 2

define nationalisation

Answer 2

where a privately owned firm or industry is taken into public ownership

Question 3

define privatisation

Answer 3

where an enterprise in public ownership is returned to private ownership

Question 4

Industries that need to build a network have… fixed costs

Answer 4

very high

Question 5

what do very high fixed costs lead to?

Answer 5

to large economies of scale available

Question 6

what does it mean for LRAC if economies of scale are so large?

Answer 6

If the economies of scale are so large that the LRAC of a firm is always downward sloping, no one firm can fully exploit them

Question 7

why may it be best that only onefirm is in the market?

Answer 7

It may be best that only one firm is in the market, to better exploit the available economies of scale so the lowest price can be charged to consumers

If there were multiple firms building separate networks, they would all have higher average fixed costs, and could not charge as low a price

• The economies of scale available are inexhaustible; productive efficiency output is at lowest AC) is beyond the demand curve. So it is most productively efficient to have a single firm - a natural monopoly

Question 8

diagram for natural monopoly, profit maximising: why is the LRAC curve declining?

Answer 8

The preceding diagrams show a declining LRAC curve, with LRMC below LRAC. This is because the available economies of scale cannot be exhausted by a single firm.
Average costs decline due to high fixed costs being spread over a greater output.

Question 9

diagram analysis, profit maximising: why can a natural monopoly be more productively efficient?

Answer 9

A single firm can satisfy market demand at a lower average cost than two or more firms, so the natural monopoly is more productively efficient. This is because a single firm avoids the wasteful duplication of a network that would occur with multiple competing firms.

Question 10

diagram analysis, allocatively efficient: with a subsidy

Answer 10

The preceding diagram shows a natural monopoly with a subsidy of (ACo-Po)xQo. This means that the price the natural monopoly receives per unit is ACo, but the consumer only pays Po. This increases the quantity produced to Qo, where Po=MC; so the natural monopoly is allocatively efficient.

Question 11

what are the 2 advantages of a natural monopoly?

Answer 11

1) greater economic efficiency
2) could be dynamically efficient

Question 12

advantages of a natural monopoly: economic efficiency

Answer 12

• More scope for productive efficiency as a single firm can better exploit economies of scale
• Could be allocatively efficient if subsidised by government

Question 13

advantages of a natural monopoly: dynamically efficient

Answer 13

Higher profit levels than a more competitive firm means more scope to invest SNP into R&D. It may choose to develop advanced technology or train workers if it knows this will keep barriers to entry high.

Question 14

what are the 3 disadvantages of natural monopoly?

Answer 14

1) low threat of competition may lead to higher prices
2) could be x-inefficient
3) could be dynamically inefficient/lack of consumer choice

Question 15

disadvantages: competition

Answer 15

Low threat of competition may lead to higher prices

• Barriers to entry are so high there is almost no threat of competing firms entering the market because a new firm will be unable to compete on price

Question 16

disadvantages: x-inefficient

Answer 16

Lack of competition reduces incentive to reduce excessive stock levels or overstaffing, leading to higher prices for consumers and lower utility

Question 17

disadvantages: could be dynamically inefficient/lack consumer choice

Answer 17

Lack of competition may mean that it does not reinvest profits to improve the quality of its products and, even though they are unhappy with the quality, consumers have to buy them anyway as there are no substitutes available

Question 18

the desirability of a natural monopoly depends on…

Answer 18

Depends on objectives. A profit maximising natural monopoly may lead to higher prices for consumers than a more competitive market. A state-owned natural monopoly with the objective of maximising societal utility can achieve a more allocatively efficient level of output than a more competitive market and, with a subsidy, can even achieve an allocatively efficient level of output. This would be especially desirable if the natural monopoly is producing a merit good.