Natural Monopoly

Published Jan 7, 2023

Definition of Natural Monopoly

A natural monopoly is a market structure in which a single firm is able to supply the entire market demand at a lower cost than two or more firms. That means it is the most efficient way to produce a good or service. This is usually the case when there are high fixed costs and low marginal costs associated with producing the good or service.

Example

A common example of a natural monopoly is the electricity industry. To illustrate this, let’s assume there are two firms in the market, Firm A and Firm B. Both firms have to pay high fixed costs to build the necessary infrastructure to produce and distribute electricity (i.e., high barriers to entry).

However, once the infrastructure is in place, the marginal cost of producing additional electricity is very low. That means if both firms were to produce electricity, they would have to split the market, and the total cost of production would be higher than if only one firm were to produce the electricity. Thus, in this case, a single firm is able to produce enough supply to meet the entire market demand at a lower cost than two or more firms.

Why Natural Monopoly Matters

Natural monopolies are important because they can lead to market inefficiencies if left unregulated. That means if a single firm is able to produce enough supply to meet the entire market demand at a lower cost than two or more firms, it can use its market power to charge higher prices and earn higher profits than if the market were competitive. This can lead to higher prices for consumers and reduced economic welfare. Therefore, it is important for governments to regulate natural monopolies in order to ensure that they are operating in the best interest of society.