Natural monopoly Flashcards
Natural monopoly
monopoly that arises in an industry in which there are such substantial economies of scale that only one firm is viable
Nationalisation
where a privately owned firm or industry is taken into public ownership
Privatisation
where an enterprise in public ownership is returned to private ownership
Examples of natural monopoly
Royal mail
Network Rail
BT
London underground
Why is there large economies of scale in natural monopoly
Industries that need to build a network have very high fixed costs, very high fixed costs leads to large economies of scale available
If the economies of scale are so large that the LRAC of a firm is always downward sloping, no one firm can fully exploit them
It may be best that only one firm is in the market, to better exploit the available economies of scale so the lowest price can be charged to consumers
If there were multiple firms building separate networks, they would all have higher average fixed costs, and could not charge as low a price
The economies of scale available are inexhaustible; productive efficiency (output is at lowest AC) is beyond the demand curve. So it is most productively efficient to have a single firm – a natural monopoly
Analysis of profit maximising natural monopoly
a declining LRAC curve, with LRMC below LRAC. This is because the available economies of scale cannot be exhausted by a single firm. Average costs decline due to high fixed costs being spread over a greater output.
A single firm can satisfy market demand at a lower average cost than two or more firms, so the natural monopoly is more productively efficient. This is because a single firm avoids the wasteful duplication of a network that would occur with multiple competing firms.
Analysis Allocatively efficient natural monopoly
shows a natural monopoly with a subsidy of (AC0-P0)xQ0. This means that the price the natural monopoly receives per unit is AC0, but the consumer only pays P0. This increases the quantity produced to Q0, where P0=MC; so the natural monopoly is allocatively efficient.
Disadvantages of natural monopoly
- Low threat of competition may lead to higher prices
Barriers to entry are so high there is almost no threat of competing firms entering the market because a new firm will be unable to compete on price
- Could be x-inefficient
Lack of competition reduces incentive to reduce excessive stock levels or overstaffing, leading to higher prices for consumers and lower utility
- Could be dynamically inefficient / lack of consumer choice
Lack of competition may mean that it does not reinvest profits to improve the quality of its products and, even though they are unhappy with the quality, consumers have to buy them anyway as there are no substitutes available
Advantages of natural monopoly
- Greater economic efficiency
More scope for productive efficiency as a single firm can better exploit economies of scale
Could be allocatively efficient if subsidised by government
- Could be dynamically efficient
Higher profit levels than a more competitive firm means more scope to invest SNP into R&D. It may choose to develop advanced technology or train workers if it knows this will keep barriers to entry high.
Judgement of natural monopoly
Depends on objectives. A profit maximising natural monopoly may lead to higher prices for consumers than a more competitive market. A state-owned natural monopoly with the objective of maximising societal utility can achieve a more allocatively efficient level of output than a more competitive market and, with a subsidy, can even achieve an allocatively efficient level of output. This would be especially desirable if the natural monopoly is producing a merit good.
