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Natural monopolies

15 February, 2016 - 09:58

Traditionally monopolies were viewed as being ‘natural’ in some sectors of the economy. This means that scale economies define some industries’ production and cost structures up to very high output levels, and that the whole market might be supplied at least cost by a single firm.

Consider the situation depicted in Figure 10.1. The long run ATC curve declines indefinitely. There is no output level where average costs begin to increase. Imagine now having several firms, each producing with a plant size corresponding to the short run average cost curve ATC_1. In contrast, one larger firm, having a plant size corresponding to ATC_2 can produce several times the output at a lower unit cost – and supply the complete market in the process. Such a scenario is termed a natural monopoly.

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Figure 10.1 A ‘natural’ monopolist 
 

When LR average costs continue to decline at very high output, one firm may be able to supply the industry at a lower unit cost than several firms. With a plant size corresponding to ATC_2, is a supplier can supply the whole market, several smaller firms, each with plan size corresponding to ATC_1, cannot compete with the larger firm on account of differential unit costs.

\mid Natural monopoly: one where the ATC of producing any output declines with the scale of operation.

We used to think of Bell Canada as a natural monopoly – before the days of cell phones and ‘voice over internet protocol’. Many nations thought of their national passenger railway as a natural monopoly – before the advent of Greyhound and the airplane. Canada Post might have had the same beliefs about itself before the advent of FEDEX, UPS and other couriers. Thus there is no guarantee that even a self-perceived natural monopoly can continue to hold that status. Entry and new developments can compete it away.

In reality there are very few pure monopolies. Facebook and Google may be extraordinarily dominant in their markets – as social media or search engines. But ultimately these firms are in the advertising business; their objective is to attract regular clients in order to push advertising. And the on-line or internet advertising business is so large that even these dominant companies get but a modest share of all such business.