Natural monopoly

Question 1

Define natural monopoly

Answer 1

Monopoly that raised in an industry where there are such substantial economies of scale that only one firm is viable

Question 2

Examples of natural monopoly

Answer 2

• royal mail
• network rail
• London underground
• national grid

Question 3

How do natural monopolies arise and why??

Answer 3

• Natural monopolies tend to be linked to the existence and logistics of physical infrastructure. These provide massively high fixed costs, which mean such large economies of scale exist that no one firm can ever exploit them
• it is therefore best that only one firm is in the market to best exploit them and charge the lowest possible price,
• if there were multiple firms the AC would be higher and therefore consumer prices
• due to inexhaustible EOS is it most productively efficient to have one firm

Question 4

What does a subsidies natural monopoly look like in the long run?

Answer 4

due to allocative efficiency, quantity levels are at AR=MC
due to the inexhaustible economies of scale, the AC and MC are downwards sloping with the AC above the MC. this results in a higher AC than price, and the difference between the two is subsidies by the government

Question 5

Advantages and disadvantages of natural monopolies

Answer 5

ADV

• greater economic efficiency- more scope for productive efficiency as a single firm can better exploit economies of scale
• could be allocative efficient is subsidised by the government
• could be dynamically efficient- higher profit levels than a more competitive market means more scope to invest into R+D. develop more advanced tech

DIS ADV

• low threat of completion may lead to higher prices due to no conditioning by competition
• could be x inefficient- lack of competition reduces incentive to reduce overstaffing or excessive stock levels
• dynamic inefficiency and lack of consumer choice again due to the lack of pressure from competition

Question 6

What does the desirability of natural monopolies depend on?

Answer 6

OBJECTIVES- a profit maximising natural monopoly may lead to higher prices and lack of dynamic efficiency, where as one which is subsidised by the government as operates at allocative efficiency (P=MC) will offer very low prices which increases consumer utility (may be state owned)