Natural Monopoly

What is a Natural Monopoly?

A natural monopoly is a market where a single seller can provide the output because of its size. A natural monopolist can produce the entire output for the market at a cost lower than what it would be if there were multiple firms operating in the market. A natural monopoly occurs when a firm enjoys extensive economies of scale in its production process.

Consider the example of heavy industries such as iron ore mining or copper mining. These industries involve large fixed costs at their onset. However, these industries are able to enjoy large economies of scale in the long run. An industry veteran holds a distinct advantage over a new firm looking to enter the business. The old firm (natural monopolist) can provide the entire market supply at a price much lower than the price the new firm would need to charge if it wants to stay in business.

Enforced Natural Monopolies

Natural monopolies are often set up by governments not to make profits but to regulate certain markets. For instance, during election season, many political parties promise to lower the prices of certain necessities in order to capture votes. A relatively easy way to achieve this is to use a government-owned natural monopolist to fix the price below the free-market price. For example, many European governments set up natural monopolies in manufacturing various lifesaving drugs.

Natural monopolies are also set up as a way of directing investment within an economy. For instance, natural monopolies in certain heavy industries prevent private investors from investing in these industries. Some governments restrict foreign private investors from investing in the nation’s heavy industries such as iron, coal, copper, and nuclear fuels.

Examples

Many of the largest energy companies in the world are natural monopolies in their respective markets. Natural monopolies are usually set up by governments for the provision of necessities such as energy and water. Utilities involve high start-up costs and require expensive infrastructure investment. Hence, natural monopolies for utilities are easily maintained by governments. However, with the development of cheap nuclear power in recent times, this may change in the near future. Telecoms, internet, and national defense are all examples of markets that experience some form of natural monopolies.

Classic examples of natural monopolies:

• Railways
• Electric utilities
• Social networks
• Search engines

Factors Affecting Degree of Influence of Monopoly Power

1. The elasticity of market demand – The higher the elasticity of demand, the lower is the monopoly power of the monopolist.
2. The number of rival firms – If a natural monopolist has a large number of rivals, then it is unable to exert much influence over the market even if it enjoys economies of scale. The rivals may sell slightly differentiated products or even artificially differentiated products in order to capture the market.
3. The degree of interaction among firms in the market – Two small producers who are not able to compete with the natural monopolist separately may merge in order to enjoy economies of scale. The threat of collusion between potential rivals is another reason why natural monopolists often lower prices below the competitive price.

Related Readings

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• Market Economy
• Command Economy
• Inelastic Demand
• Law of Supply
• See all economics resources