What is a Natural Monopoly?

//What is a Natural Monopoly?
What is a Natural Monopoly? 2017-10-06T01:15:17+00:00

Definition: A natural monopoly arises when a single firm supplies the entire market with a particular product or a service without any competition because of large barriers to entry. These barriers to entry can include high start up costs, high fixed costs, difficulty in obtaining the needed raw materials, as well as many other things.

What Does Natural Monopoly Mean?

In other words, it’s when one company controls a market because of unique product, manufacturing, or market conditions. A natural monopoly is exactly what the name suggests. It occurs naturally without collusion or unfair play. A NM is less concerned about new entrants in the market that could undermine its market share and power. Companies that consider entering the market are aware that they cannot compete at the low cost that the NM competes because there are typically large economies of scale involved. It’s too difficult to enter.

Usually, natural monopolies operate in industries that require advanced technology and/or raw materials to operate. Although a NM faces high fixed production costs and high distribution costs, the average cost declines to the point that the demand curve intersects the average cost curve. Typical examples of natural monopolies are companies operating in the energy production and distribution, the distribution of water, public transportation, telecommunications, and post office.

The government allows natural monopolies, but it regulates them with the Federal Trade Commission Bureau of Competition to protect consumers. If consumers can’t be protected, the government might nationalize the monopolies in the market.

Let’s look at an example.

Example

A utility company is a good example of this concept. Utility companies must run power lines, water pipes, and sewer systems. Cities can’t allow multiple companies to run all of these things to each house in their district. The logistics wouldn’t work. Instead, one company is allows to have control over its own utility system.

Company A, for instance, is a government-regulated water company in Anderson, CA. To ensure the provision of water to the residents of Anderson, the company needs to build a water pipeline network across town.

Two or more companies cannot compete in providing this service because they can’t acquire their own water supply or build the piping network needed to run this service. Thus, Company A operates in the market by itself and faces a lower material cost due to the lack of competition while servicing the entire town.