NATURAL MONOPOLY EXPLAINED

A natural monopoly is a market condition whereby a firm has a large cost advantage over the quantity demanded.

Put in another way, a natural monopoly is a condition whereby a supplier has an overwhelming cost advantage such that he would be able to serve the entire market demand at a lower cost than any combination of competitive firms.

Natural monopoly can also refer to a situation where market output is produced at the lowest cost when production is concentrated in the hands of a single firm.

Natural monopoly usually exists when the economics of scale is so pronounced that only one firm can survive successfully in the industry.

The total cost of a natural monopoly is largely made up of fixed costs. As an example of a natural monopoly, electricity distribution companies exist. The fixed cost of building a transmission network (like an electricity line) is high. 

It will cost for a potential firm to entirely build a second electricity line. Plus, it would be a great waste of economic resources to do so.

This could effectively bar firms from entering the market.

Another thing you should know about natural monopoly is that its course structure is different from other firms.

This is because a natural monopoly's average cost is not u-shaped. Rather it is down-sloping.

But, Why is this so?

The total cost of a natural monopoly is largely made up of fixed costs. And fixed costs, as I have told you before, are constant. 

Hence the average total cost of natural monopoly will be downward sloping as the average total cost is largely made up of average fixed costs.

Similarly, the marginal cost of natural monopolies is also different from other firms. Natural monopolies normally have a constant or decreasing marginal cost, as opposed to the typical u-shaped marginal cost of other firms.


Figure (a) illustrates the natural monopoly. As can be seen, the long-run average cost continues to fall. This indicates the economics of scale enjoyed by the natural monopoly.

This is indicative of the fact that only a single firm can serve the industry efficiently because of the economics of scale.

Though natural monopoly is advantageous in a specific sense, it could also act as an incentive for illegal pricing practices like predatory pricing.

Predatory pricing is the practice of lowering prices in other to deter competition. 

In predatory pricing, the firm cut prices sharply to frustrate competition. 

Natural monopoly usually has economies of scale, which means, there can produce costs at the lowest cost that other competitors would. 

For this reason, they can cut prices sharply. This is because they can lower prices and still make a profit(though not much) whereas potential competitors may not earn a profit if they decide the lower price because they are producing at a higher per-unit cost than the natural monopoly.

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