Natural Monopoly Essay

Explain that the main characteristics of a natural monopoly (15)

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  • Created on: 23-06-11 17:08
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Explain that the main characteristics of a natural monopoly (15)
A natural monopoly is a market situation where a monopolist has overwhelming cost
advantage. It exists when there is great scope for economies of scale to be exploited
ever a very large range of output, which allows that dominant producer to enjoy
lower costs of production than any other potential competitor. This may in theory
come about if the monopoly has sole ownership over a resource (for example
through a patent) or the physical railway track on a particular route. Here for
example as output increases, average costs will fall, offering the prospect of
substantial benefits to be gained from economies of scale.
The diagram below represents a natural monopoly. It shows how the long run
average cost curve falls over time representing continuing economies of scale. The
monopoly would set prices at P1, provided Q1, and earned supernormal profits
Price and costs
Abnormal Profit
PC1 Subsidy for private monopoly
PC2 LRAC
LRMC
AR
MR
output
Q1 Q2
The monopoly would set prices were MC=MR (profit maximization). As the monopo
Inlist average cost continued to fall significantly up to the output that satisfies the
whole market then there is only room for one supplier to achieve productive
efficiency or get close to achieving production efficiency. If there was more than one
operator then they would individually face much higher long-run average costs.
Natural monopolies tend to occur in industries where there are high fixed costs, from
sample railways (tracks) and gas (pipes). This is because firms can undercut rivals
by exploiting economies of scale by producing a greater level of output at a lower
cost. They can produce the output at a lower cost and force smaller competitors
(who lack the economies of scale) out of the market.
If the firm behaved as a competitive company, the equilibrium position would be
where price is equal to long-run marginal costs. The price would be lower at P2
enter quantity provided would be higher at Q2. However the average cost would be

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Bus services in rural
areas are often subsidized by the government in order for them to be allocatively
the efficient as they would not otherwise be operated.
Although a monopoly may exploit consumers through restricting output and
increasing prices, consumers generally benefit from economies of scale which can
only be achieved by a monopoly. Companies may be more inclined to undertake
research and development which benefits the consumer.…read more

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