Question

How does a natural monopoly differ from a standard monopoly (you should discuss the relationshipbetweencostcurves and the demand curve)?What doesthis mean from a policy perspective?

Answer 1

Both types of monopoly arises from the market comprising only one firm. However, a standard monopoly may arises from government regulation, the firm's unique access to an essential technology (e.g. holding a product patent), unique access to distribution channels (e.g. suppliers) or strong brand value that acts as an entry deterrent. But a natural monopoly arises only from cost advantage. For a natural monopolist, long run average total cost (ATC) falls with increase in output, so the firm enjoys economies of scale. Therefore, while both forms of monopoly face a downward sloping demand curve, the ATC curve for standard monopolist is U-shaped while the ATC curve for natural monopolist is downward sloping.

From a policy perspective this means that a natural monopolist is less likely to be subject to pricing regulation, since due to a cost advantage, the firm is likely to keep prices lower compared to a standard monopolist. Therefore, policy intervention is less likely for a natural monopolist.