Natural Monopoly

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Definition: Natural Monopoly

A natural monopoly exists in an industry that is marked by high barriers of entry and high fixed costs of operation. In such an industry, it is economically efficient to have a monopoly as opposed to competition as a result of the high capital requirements for being in operation. In a natural monopoly, the largest supplier or producer in the industry has a high cost advantage over other competitors as a result of economies of scale and as such, a natural monopoly eventually becomes an actual monopoly.

Examples of natural monopolies include public utilities such as electricity, water supplies, gas, railways, etc where the cost of setting up production and supplying to each household is very high. As such, the government can regulate the firms in natural monopolies to ensure that consumers can benefit from such an economic structure by preventing situations of low supply, excessive price increments, etc.

In a natural economy, there is a high fixed cost attributed to the high initial capital required. The marginal cost of production, i.e. the incremental cost of producing an additional unit is constant. As such, the average cost curve in such an industry is a decreasing function of the quantity produced or the number of consumers served. This is due to the economies of scale achieved in operation. The average cost exceeds the marginal cost of production over a relevant range of output allowing the monopoly firm to operate at low average costs.

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