Question

What is the definition of a natural monopoly? Give a couple of examples of the companies that would be considered natural monopolies. Briefly explain the reason why they are called "natural" and why they are economically desirable. Can natural monopolies maintain their status forever? Briefly explain your answer.

Answer 1

Natural monopoly is a situation where there is a single seller in the market due to high capital cost and fixed cost. In other words natural monopoly exist because there is very high cost required to set up the industry and that is why competitors does not exist. It is called natural because there is single seller by nature due to high capital cost which acts a barrier for competitors and they are not capable of entering the industry. In natural monopoly fixed cost is very high but marginal cost of producing a product is low. In this monopply average cost decreases with the increase in output supplied and a single firm can better supply at low price then the group of companies.

Example of natural monopoly includes public utilites such as electricity supply, water supply, railways etc. We have seen that these firms do not have competitors as setup cost is very high.

As there is single seller in the market and it may happen that they want to earn high profit by increasing prices because they are the only sellers and consumers have no choice to go for alternatives, this will be an exploitative move. To prevent such things government regulate these industries and ensure that prices are economically ethical.

Natural monopoly is desirable because the single seller have the capability to satisfy all the people at a lower cost. Suppose there are other firms entering in the market and there are several companies providing railway facilities, water supply and electricity supply. This will create competition in the market and there will be price war, as a result prices will go up and consumers will have to purchase these commodities at higher price. In natural monopoly a single firms supplies at lower rate than cartel of firms.

Such type of industries exist in the economy with the support of government regulations and for public welfare. This types of monoply can exist for longer time or some forever. Due to barries in the market competitiors do not exist.