Natural Monopoly

10 Key excerpts on "Natural Monopoly"

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  Natural Monopolies in Digital Platform Markets

  • Francesco Ducci(Author)
  • 2020(Publication Date)
  • Cambridge University Press

    (Publisher)

  industries), technology overall appears to have the opposite effect on the current wave of digital platform markets, enabling economic conditions that increase rather than decrease the likelihood of natural monopolies. After describing the general economic preconditions for the emergence of natural monopolies, the chapter identifies the specific determinants of natural and efficient concentration that can arise in platform markets, and then discusses different forms of regulatory interven- tion potentially pertinent to markets with Natural Monopoly features. 2.3.1 The Standard Natural Monopoly Paradigm The distinguishing feature of a Natural Monopoly is that the most efficient way to serve the market is to have a single firm serving the entire demand, as a single firm is able to operate in the market at a lower cost than several firms operating in the market. Competition and fragmentation, on the contrary, is not viable for natural monopolies. 134 More than one provider would create wasteful duplication of facil- ities increasing costs of producing total output, whereas a Natural Monopoly is the only structure that takes full advantage of internal scale economies relative to the size of demand as a result of decreasing long-run average unit costs over all or most of the extent of the market. An economic definition of a Natural Monopoly is that the product and firm cost functions are said to be subadditive at the output level. 135 That is, a firm producing a single homogeneous product is a Natural Monopoly when the cost advantage in producing any level of output within a single firm (rather than with two or more firms) holds over the full range of market demand.

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  Electricity Marginal Cost Pricing

  Applications in Eliciting Demand Responses

  • Monica Greer(Author)
  • 2012(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Chapter 2

  The Theory of Natural Monopoly and Literature Review

  The Natural Monopoly Conundrum

  Historically, conventional wisdom has held that certain markets were “naturally monopolistic,” which means that, due to the presence of high fixed costs of which the average declines with increases in output, efficiency is best obtained when there is only one supplier. According to Kahn (1970 , p. 15),

  … the public utility industries are preeminently characterized in important respects by decreasing unit costs with increasing levels of output. That is indeed one important reason why they are organized as regulated monopolies: a “Natural Monopoly” is an industry in which the economies of scale are such that one company supplies the entire demand. It is a reason, also, why competition is not supposed to work well in these industries.

  Included herein are the markets for electricity, natural gas, telephone, and water services. It has often been argued that what is driving this phenomenon is the irreversibility of the initial investment required to produce a particular good or service in a naturally monopolistic industry. More specifically, the underlying production technology of this product is such that a level of output exists for which average cost is minimized; at levels of output below this level average costs decline, and at levels above they rise. This is known as economies of scale and is investigated further in context to its relationship with the theory of Natural Monopoly.

  Economists have spent many years attempting to assess that level of output at which the minimum efficient scale occurs. In some industries, such as the generation of electricity, a consensus has been reached that, at least in 1970, most firms were producing in and around this level, given a particular production technology (Christensen and Greene, 1976

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  Business and Managerial Economics

  • (Author)
  • 2014(Publication Date)
  • College Publishing House

    (Publisher)

  The exploitation of economies of scale helps explain why companies grow large in some industries. It is also a justification for free trade policies, since some economies of scale may require a larger market than is possible within a particular country — for example, it would not be efficient for Liechtenstein to have its own car maker, if they would only sell to their local market. A lone car maker may be profitable, however, if they export cars to global markets in addition to selling to the local market. Economies of scale also play a role in a Natural Monopoly. Natural Monopoly A Natural Monopoly is often defined as a firm which enjoys economies of scale for all reasonable firm sizes; because it is always more efficient for one firm to expand than for new firms to be established, the Natural Monopoly has no competition. Because it has no competition, it is likely the monopoly has significant market power. Hence, some industries that have been claimed to be characterized by Natural Monopoly have been regulated or publicly-owned. A Natural Monopoly arises where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual and potential competitors. This tends to be the case in industries where capital costs predominate, creating economies of scale that are large in relation to the size of the market, and hence high barriers to entry; examples include public utilities such as water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines); therefore, it is unlikely that a potential competitor would be willing to make the capital investment needed to even enter the monopolist's market. Some free-market-oriented economists argue that natural monopolies exist only in theory, and not in practice, or that they exist only as transient states. Explanation All industries have costs associated with entering them.

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  Microeconomics

  • David Besanko, Ronald Braeutigam(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  To do so, we first study the concept of a Natural Monopoly. Then, we explore the notion of barriers to entry. deadweight loss due to monopoly The difference between the net economic benefit that would arise if the market were perfectly competi- tive and the net economic benefit attained at the monopoly equilibrium. rent-seeking activities Activities aimed at creating or preserving monopoly power. WHY DO MONOPOLY MARKETS EXIST? 11.6 CHAPTER 11 MONOPOLY AND MONOPSONY 502 Natural Monopoly A market is a Natural Monopoly if, for any relevant level of industry output, the total cost a single firm producing that output would incur is less than the combined total cost that two or more firms would incur if they divided that output among them. A good example of a Natural Monopoly is satellite television broadcasting. If, for example, two firms split a market consisting of 50 million subscribers, each must incur the cost of buying, launching, and maintaining a satellite to provide service to its 25 million subscribers. But if a single firm serves the entire market, the satellite that served 25 million subscribers can just as well serve 50 million subscribers. That is, the cost of the satellite is fixed: It does not go up as the number of subscribers goes up. A single firm needs just one satellite to serve the market, while two independent firms would need two satellites to serve the same number of subscribers overall. Figure 11.17 shows a Natural Monopoly market. The market demand curve is D, and each firm has access to a technology that generates a long-run average cost curve AC. For any output less than 10,000 units per year, a single firm can produce output more cheaply than two or more firms could. To illustrate why, consider an output level Q = 9,000 units per year. A single firm’s total cost of producing 9,000 units per year is TC(9,000) = 9,000 × AC(9,000) = $9,000, since AC(9,000) = $1. Suppose we divided this output equally between two firms.

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  Competition Policy for Small Market Economies

  • Michal S. Gal, Michal S. GAL(Authors)
  • 2009(Publication Date)
  • Harvard University Press

    (Publisher)

  2 Natural monopolies may also arise in network in-dustries, in which the system becomes more valuable to a particu-lar user as the number of other users is increased. 3 Under such cir-cumstances, monopoly is accepted as the most appropriate industry structure. This is why such monopolies are termed “natural”: they re-sult from the natural conditions of the market. The natural monop-oly market may encompass a region, the whole domestic market, or even the global market. Natural monopolies have arisen, for example, in connection with harbors, 4 airports, 5 local newspapers, 6 electricity transmission grids, 7 and bus terminals. 8 A related phenomenon involves government-created facilities or services known as “essential facilities,” which cannot be economically duplicated for policy reasons. 9 To illustrate, environmental objections or land-use restrictions may make it impossible to build a competing 112 • Competition Policy for Small Market Economies airport although market demand might be sufficient to support two airports. Other legal rules, such as intellectual property rights, may also restrict the ability of competing firms to operate in the market. Essential facilities may also exist when one competitor has assumed control over all the alternative sources of at least one critical ele-ment necessary to compete. They should be distinguished from natu-ral monopolies. Essential facilities can often be eroded by removing the artificial barriers to entry that created them in the first place. Con-trol of potentially competing facilities by one firm can be eliminated by separation of ownership. Natural monopolies, however, can lose their “natural” status only if one of the two market conditions that define natural monopolies change—either market demand grows sig-nificantly or technology erodes economies of scale.

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  Industrial Organization

  Competition, Growth and Structural Change

  • Kenneth George, Caroline Joll, E L Lynk(Authors)
  • 2005(Publication Date)
  • Routledge

    (Publisher)

  Chapter 13 Natural Monopoly 13.1 INTRODUCTION The previous chapter dealt with the costs that the incidence of private monopoly may impose upon society owing to the lower levels of output and higher prices than would prevail under a competitive environment. Clearly the outcome of such an approach is that, at the static level at least, monopoly may be undesirable from the viewpoint of economic efficiency. However, there are instances where efficiency dictates that demand is met by a single producer. This is the case of Natural Monopoly. In such a situation the costs of supply exhibit characteristics such that single-firm production is always more efficient than multi-firm production. In the single-product case such a situation is caused by substantial (and often unexploited) economies of scale induced by a high fixed cost component. In a multiproduct industry it is largely caused by a combination of economies of scale and scope. In such circumstances there is clearly a public policy problem. This is because, although efficiency requires single-firm production, this may occur at the expense of allocative efficiency. The monopolist is in a powerful position to charge prices that more than cover costs of production. The Natural Monopoly problem therefore is one of ensuring that industry output is produced at minimum cost (private and social) and sold at prices that reflect these costs. The postwar approach in the UK until the 1980s was the exclusive public ownership of such activities. Apparent dissatisfaction with this solution has led to the recent programme of privatisation accompanied by regulation. In this chapter we first consider the conditions which give rise to the Natural Monopoly problem and the welfare issues raised. We also look at the practical policy issues raised and the ‘solutions’ adopted: public ownership (section 13.4), privatisation (section 13.5) and regulation (section 13.6)

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  Handbook of Law and Economics

  • A. Mitchell Polinsky, Steven Shavell(Authors)
  • 2007(Publication Date)
  • North Holland

    (Publisher)

  Carlton and Perloff (2004, p. 104) write that “When total production costs would rise if two or more firms produced instead of one, the single firm in a market is called a “Natural Monopoly.”

  These are simple expositions of the technological definition of Natural Monopoly: a firm producing a single homogeneous product is a Natural Monopoly when it is less costly to produce any level of output of this product within a single firm than with two or more firms. In addition, this “cost dominance” relationship must hold over the full range of market demand for this product .

  Consider a market for a homogeneous product where each of k firms produces output and total output is given by . Each firm has an identical cost function . According to the technological or cost-based definition of Natural Monopoly, a Natural Monopoly will exist when:

  since it is less costly to supply output Q with a single firm rather than splitting production up between two or more competing firms. Firm cost functions that have this attribute are said to be subadditive at output level Q (Sharkey, 1982 , p. 2). When firm cost functions have this attribute for all values of Q (or all values consistent with supplying all of the demand for the product ) then the cost function is said to be globally subadditive . As a result, according to the technological definition of Natural Monopoly, a necessary condition for a Natural Monopoly to exist for output Q of some good is that the cost of producing that good is subadditive at Q .

  Assume that firm i’s cost function is defined as:1

  then the firm’s average cost of production

  declines continuously as its output expands. When a firm’s average cost of production declines as its output expands its production technology is characterized by economies of scale . A cost function for a single-product firm characterized by declining average total cost over the relevant range of industry output from 0 to is subadditive over this output range. Accordingly, in the single product context, economies of scale over the relevant range of q is a sufficient condition to meet the technological definition of Natural Monopoly. Figure 1 depicts the cost function for a firm with economies of scale that extend well beyond the total market demand (Q ) depicted by the inverse demand function . We note as well that when there are economies of scale up to firm out level q it will also be the case that average cost will be greater than marginal cost over this range of output ( in the simple example above).2

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  The Political Economy of Pipelines

  A Century of Comparative Institutional Development

  • Jeff D. Makholm(Author)
  • 2012(Publication Date)
  • University of Chicago Press

    (Publisher)

  Who is right—those who would treat pipelines as natural monopolies or those who would dispense with pipeline regulation altogether? It is a false dilemma flowing from a constrained point of view. The neoclassical economic perspective of production cost that leads to the concept of Natural Monopoly is insufficient to capture asset specificity—the key aspect of the pipeline industry that separates it from other businesses. But insufficient does not mean irrelevant: the cost structure of pipelines is an important part of understanding the nature of the business at particular locations and at particular points in time. This chapter looks at that cost structure and takes such traditional neoclassical economics as far as it will go to explain behavior in this industry—as much as anything to remove Natural Monopoly as an obstacle to a more useful institutional analysis. For despite the economics of Natural Monopoly, such a cost structure does not lead naturally to monopoly in real-world pipeline transport markets. Using practical examples from actual pipeline transport markets, it is easy enough to show that Natural Monopoly has failed in practice to produce a single, investor-owned pipeline in a major regional fuel market.

  The Theory of Natural Monopoly for Pipelines

  Economists are in wide agreement on the basic economic theory of Natural Monopoly. A statement regarding the theory appears in almost every elementary economics textbook. As in the case of perfect competition, however, Natural Monopoly is an abstract and static ideal, and there is no particular reason to believe that the textbook definition applies to real pipeline businesses any more than perfect competition applies in other markets.3

  Are pipelines natural monopolies, either individually or as parts of interconnected systems? It is inescapably true that between two points, for a specified increment of demand, a single pipeline is less costly than two.4 Figure 1 illustrates a traditional Natural Monopoly, where average cost declines throughout the entire range of output. If unregulated, a firm setting a single price for its services would produce the quantity at which its marginal cost equals its marginal revenue, or Y m at P m . Ideally, the regulatory agency, if there is one, would like to compel the firm to produce the competitive output, Y c . But at that output, demand does not permit charging a price that covers average cost, and the firm could not survive without tax-financed (or other) subsidies. In this case, the best that a regulator can do to mimic a competitive outcome is to set a price equal to average cost, allowing the company to serve the demand at that price level, Y r and P r

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  Intermediate Microeconomics

  Neoclassical and Factually-oriented Models

  • Lester O. Bumas(Author)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

    Monopolies with the power to set price have the power to set it unreasonably high. That some unregulated monopolies charge no more than regulated monopolies may well be due to the fear that those which are unregulated may will lose that status if their prices are unreasonably high. There is in addition the profound problem of the political power of monopolies and big business in general. They have great influence on government at all levels and make a mockery of the essence of democracy which can be characterized as “one person, one vote.” And if monopolies, big business, and banks seem to be sinking they tend to be bailed-out by the government in what appears to be an arrangement in which risk is socialized and profits privatized.

  Summary

  Monopolies and monopolization play an important role in our economy and its history. There are two kinds of monopolies, natural and unnatural. Natural monopolies exist because they can produce more cheaply than two or more firms in a market. They are the beneficiaries of economies of scale. But in choosing the most efficient size of plant, production is expected to take place in the declining range of the average cost function, the range in which marginal cost is lower than average cost. This precludes the efficient allocation of resources as manifest in marginal cost pricing. Moreover, if a natural monopolist wants to avoid being displaced by a rival, it must choose its plant size based on the normal rate of return rather than profit maximization.

    Unnatural monopolies arise from numerous sources: government grants of monopoly status in the form of patents and franchises; the control of necessary resources; and the historic establishment of organizational forms such as pools, trusts, holding companies, and cartels. And while unnatural monopolies do not have the advantage of economies of scale, by going to multiplant operations they can largely avoid diseconomies of scale.

    Price discrimination is practiced by monopolies (and other price-setting firms). This is obvious in the case of public utilities, which tend to have different rate schedules for residential, business, and religious institutions. Price discrimination can be a tool for increasing profits beyond that possible with a single price. Utilities frequently have a monthly base charge. This means that price varies with the rate of consumption: the lower the number of units purchased, the higher is the per unit price.

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  Study Guide for Essentials of Economics

  • J. R. Clark(Author)
  • 2014(Publication Date)
  • Academic Press

    (Publisher)

  some firms would leave the industry for opportunities where economic profits exist c. firms would more than likely be earning accounting profits d. all of the above would be true. 7. In the case of Natural Monopoly, if the producing firm were broken into several smaller competing firms, which of the following could be expected to occur? a. Each of the smaller firms would have higher per unit production costs. b. Prices paid by the consumer would fall as a result of competition in the industry. c. Each of the smaller firms would be able to take advantage of economies of scale. d. none of the above 8. The perfect competitor maximizes profit by producing where marginal cost equals price. The monopolist differs from this behavior in that: a. in a monopoly, price is higher than marginal revenue b. the monopolist sets output by MR = MC and then charges the highest price consumers are willing to pay for that amount of output. c. Both a and b are correct. d. None of the above are correct. 114 Chapter Thirteen SECTION THREE Vocabulary Self-Test 1. '. is characterized by rivalry between firms, each trying to provide a better deal to buyers when price, quality, and product information are considered. 2. A large number of firms that produce a homogeneous product in an industry with ease of entry and exit characterizes the model of . 3. A product of one firm that is no different from the product of every other firm in the industry is . 4. are obstacles that prevent potential rival firms from freely entering an industry. 5. Sellers facing a horizontal demand curve are , who must adopt the market price in order to sell their product. 6. The change in total revenue derived from the sale of one additional unit of a product is 7. The temporary closing of a business with the intent to reopen in the future is a , during which fixed costs are still incurred. 8. is the permanent exit of a firm from the market; it is characterized by the sale of the firm's assets.

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