B2.01.13: Natural Monopoly

Question 1

Define natural monopoly

Answer 1

Where only 1 large firm can supply the entire market at a lower AC contrasted with multiple producers. There are also very high fixed costs

Question 2

Draw a natural monopoly diagram in the short run (where supernormal profits are being made)

Answer 2

• D1=AR1 curve is a downwards sloping demand curve
• MR curve is twice as steep
• LRAC curve intersects MR curve and extends to intersect D1=AR1 curve
• LRMC curve intersects MR curve at a much lower point and extends to intersect D1=AR1 curve but lower than LRAC curve
• MR = MC point is plotted and drawn upwards to first intersection labelled point B and horizontally drawn and labelled C1. Line drawn upwards to second intersection and labelled point A and horizontally drawn and labelled P1. Line drawn vertically downwards and labelled Q1.
• ABCP shows total supernormal profit

Question 3

Draw a natural monopoly diagram in the long run (where subnormal profits are being made - losses)

Answer 3

• Allocative efficiency point is plotted labelled F (AR=MC) and horizontal line is drawn and labelled P2 and vertically drawn downwards and labelled Q2 and vertically drawn upwards until first intersection labelled E and drawn horizontally and labelled C2
• EFCP shows total subnormal profit

Question 4

How can natural monopolies start making normal profits again in the long run

Answer 4

• Find Allocative Efficiency point and vertical line is drawn downwards and labelled Q2.
• This shows that a natural monopoly has to produce a much greater quantity in order to make normal profits. This is the Point of Regulation.
• At the POR, a subsidy is given to regulate the losses incurred by the natural monopoly allowing them to, at least, make normal profits

Question 5

What are the 4 main features of natural monopolies

Answer 5

• Huge fixed costs
• Enormous potential for Economies of Scale
• Makes rational sense for only 1 firm to supply the entire market
• Competition would result in a wasteful duplication of resources and non-exploitation of full Economies of Scale resulting in Allocative and Productive inefficiency

Question 6

How is there an enormous potential for Economies of scale

Answer 6

• There’s opportunity for great amounts of profits

Question 7

Why does it make rational sense for only 1 firm to supply the entire market

Answer 7

• Competition is undesirable here as it would result in a wasteful duplication of resources

Question 8

Why is there a wasteful duplication of resources?

Answer 8

• The 1st new firm in the market has got the EOS advantage
• Firms following this firm won’t have as much of an advantage hence, they’re going to be priced out the market.
• This means that their prices aren’t low enough.
• As these firms leave the market, all their resources will be left alone hence, a giant waste of duplication of resources occurs

Question 9

Example of a natural monopoly

Answer 9

Fibre-optic broadband network

Question 10

What would it mean for the natural monopoly if there are very high fixed costs

Answer 10

• Competition in this type of market structure may not be