Natural Monopoly

Question 1

What is a natural monopoly?

Answer 1

A natural monopoly is where it would be a waste of resources i.e. inefficient, to have more than one firm in the market. This occurs when a business has to deliver a basic infrastructure which tends to be very expensive, which is needed to deliver its product or service to all of the customers.

Question 2

What would happen if a new firm entered the market?

Answer 2

If we were going to have competition in these markets, we would have to duplicate all this infrastructure. That would be very expensive, and neither business would be able to use that infrastructure at maximum efficiency. I.e. it would be a waste of resources

Question 3

Advantages of natural monopoly

Answer 3

1 - Can benefit from significant economies of scale. Because of these costs and prices may actually be lower in monopoly compared to other markets. E.g. if we compare monopoly with perfect competition (graph)

2 - It may be a natural monopoly, so having competition in that market would be inefficient

3 - some monopoly’s may feature fairly high levels of dynamic efficiency because:

• They can afford too
• To create barriers to entry

Question 4

Disadvantages of natural monopoly

Answer 4

1 - consumers have no real choice

2 - A monopoly will tend to try to use its market position to increase its prices

3 - Because there’s no competition, a monopoly is not under enough pressure to feature productive or allocative efficiency

4 - A monopoly will tend to feature X-inefficiency

Question 5

What is X-Inefficiency?

Answer 5

This is where a monopoly is so big, and makes profits every year, and that will tend to make them complacent I.e. they don’t push themselves as bad as they should, therefore they become more efficient

Question 6

What are regulators?

Answer 6

Regulators are set by the government to control natural monopolies. Their objective is to protect consumers e.g. OFWAT controls the water companies.

Question 7

What are the 2 main objectives of regulators?

Answer 7

1 - Set minimum standards that consumers can expect from their services e.g. trains on time

2 - Control the prices by setting a maximum price. If they think the industry is capable of becoming more efficient they might set a lower maximum price to push them into efficiency. However if they think the industry need more money to invest more into the industry, they might increase maximum price.