Question

What is a natural monopoly? Why is government justified in regulating a natural monopoly?

Answer 1

A natural monopoly is a type of monopoly that exists when the fixed cost of production is very high and it becomes impossible to have one than one firm producing the good. Some examples include railway infrastructure, gas pipelines etc. A natural monopoly is mainly owned by the government and is mainly seen in case of utilities. It is seen seen when a prime natural resource is owned by the government or a single firm has control over the resources.

Since a natural monopoly is a single producer of a good there are strong incentives for a natural monopolist to abuse their market position to increase their profits. This also includes charging high prices, selling lower quality products, indulging in corrupt practices etc . This calls for government regulation in such industries. Government has been regulating natural monopolies by using various pricing schemes involving marginal cost pricing, average cost pricing etc. This helps in keeping prices at reasonable level in an industry which is highly prone to charging high prices.