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--INITIAL THOUGHTS--
--INITIAL THOUGHTS--
"Despite water, electricity and the subway being essential necessities, that allows providers to earn extensive abnormal profits, why do you think they are almost always dominated by one firm with little to no competition?" "What is the barrier to entry?" "Is it just money and start up costs alone?"
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"No, it's not about the money, as I could easily afford to build and maintain a rival MTR in Hong Kong, however..."
"...sharing this market means that both of us would struggle to be profitable, and the very nature of these high-fixed-cost industries means that a single firm can in fact experience economies of scale over the entire market demand, so to compete against that cost advantage would be folly!"
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--DEFINITION--
--DEFINITION--
"A NATURAL MONOPOLY is therefore a firm that has ECONOMIES OF SCALE SO LARGE that it is POSSIBLE FOR A SINGLE FIRM TO SATISFY THE ENTIRE MARKET at a LOWER AVERAGE COST than TWO or MORE firms."
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"When one is better than three"
--"WHY IS ONE BETTER THAN TWO?"--
--"WHY IS ONE BETTER THAN TWO?"--
"We are regularly told that competition and efficiency is good and a monopoly is always bad so how can one firm ever be the preferred option?"
"We are regularly told that competition and efficiency is good and a monopoly is always bad so how can one firm ever be the preferred option?"
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"Now Mr. Li above mentioned that two MTR firms would struggle to be profitable if they had to share the market." "Can you think of what is particularly high in this type of industry, similar to the electricity and water industries?"
"Now Mr. Li above mentioned that two MTR firms would struggle to be profitable if they had to share the market." "Can you think of what is particularly high in this type of industry, similar to the electricity and water industries?"
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"That's right, they have extremely high fixed costs as well as very high running and maintenance costs." "Can you imagine two underground tunnel or waterpipe networks running next to each other?" "What a waste!!!"
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"Therefore, they need a lot of revenue to make the business profitable or at least viable, which requires that they capture almost all of the market, as sharing it with a rival would not likely leave them at a loss."
"Therefore, they need a lot of revenue to make the business profitable or at least viable, which requires that they capture almost all of the market, as sharing it with a rival would not likely leave them at a loss."
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"Furthermore when the major portion of your costs are fixed, what happens to your average costs as output rises?"
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"That's right!, they continuously fall, as these types of firms have extremely large 'minimum efficient scales,' which means they can experience economies of scale over a very large level of output, so the more of the market they are allowed to supply, the lower they can get their average costs, so in terms of getting the lowest average costs, 'one is definately preferred to two or more'."
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"...to sum up, we can say that "the benefits of competition and efficiency can be outweighed by the benefits of economics of scale in terms of finding the lowest cost producer."
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--"WHO IS IN CONTROL?"--
--"WHO IS IN CONTROL?"--
"If we have a single private-sector producer of a very, very inelastic service that has no natural competition, what do you think might happen regarding the price they charge and the level of output they produce?"
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"That's right, a rational profit-maximising firm will charge a very high price and produce way below the socially optimal level; however, if we were to look at the main examples of natural monopolies they provide merit goods ('necessities') such as clean water, electricity, and transportation, which, as we know, are underconsumed in the free market." "So how can we ensure these essential services are provided at the socially optimal levels at affordable prices?"
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"That's right, the government intervenes to stop them acting like 'crazy monopolies,' usually through 'regulated price controls,' basically declaring to them the following..."
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"Sorry, guys, you can't maximise profits (@MC=MR) anymore..."
"...you can only earn normal profits by setting your price where AC=AR, called 'Average cost pricing' or..."
"...produce at the socially optimal level by setting your price where MC=AR, called 'Marginal cost pricing, and we will subsidise any losses!"
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--DIAGRAM 1 VS 2--
--DIAGRAM 1 VS 2--
We can see that if we force the natural monopoly to only make normal profits and produce where AC=AR then they could satisfy the entire market at AC100%.
However, if we introduced a second firm into this market, and assume that they each take 50% of the market share, the lowest average costs that they could achieve would be AC50%.
A market in which the demand for the product intersects the single firm’s average total cost curve while it is still downward sloping. In other words, there is not enough demand to warrant more than one firm producing the good. Society is actually better off with a single producer. Examples include utilities such as electricity and water. Often natural monopolies are regulated by government to assure a more socially optimal level of output and price.
--PRICE CONTROL--
--PRICE CONTROL--
The fact that these industries don't naturally face any competitive pressures, means they can act like all monopolies, and produce the quantity at which their profits are maximised (Where MC=MR), and where abnormal profits can be earned (AR>AC) which is always below the allocative efficient level (AR=MC).
However, the fact that these industries are usually related to the provision of necessities, such as WATER AND POWER SUPPLIES, compels governments to intervene and prevent them from abusing their monopoly power by forcing them to either produce where P=AR=AC ('AVERAGE COST PRICING') or where P=AR=MC ('MARGINAL COST PRICING') *
*This is covered in more detail in the 'Monopoly abuse' section.
https://www.economicsdiscussion.net/cost/short-run-and-long-run-average-cost-curve/25523
--LRATC: NATURAL--
--LRATC: NATURAL--
So in answer to the initial question, WHAT'S THE DIFFERENCE BETWEEN REGULAR AND NATURAL MONOPOLIES COST CURVES? in a natural monopoly the range of output at which AFC FALLS at a HIGHER RATE than AVC rises, is large enough to satisfy the entire market and still make normal profits.
Given this, we can further conclude that THE LARGER A FIRM'S TOTAL FIXED COSTS RELATIVE TO THEIR TOTAL VARIABLE COSTS, THE GREATER THE RANGE OF OUTPUT THAT LRATC and LRMC FALL (economies of scale).
So NATURAL MONOPOLIES ARE THOSE FIRMS WHO INCUR EXTREMELY HIGH START-UP FIXED COSTS RELATIVE TO THEIR VARIABLE COSTS such as water, electricity, telecom and subway providers, which all need to spend billions on infrastructure before selling one unit.
Below shows the contrast in cost curves between a monopoly with a relatively low fixed cost to variable cost ratio, and a natural monopoly with a very high fixed cost to variable cost ratio. We can see that the natural monopoly's average and marginal costs fall over the entire market demand, clearly illustrating that a single firm can satisfy more of the market than two or more competing firms who wouldn't be able to exploit the economies of scale that a single firm could.
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