<NATURAL MONOPOLY>

 --I think you would agree that WATER, ELECTRICITY, and TELECOM are ESSENTIAL NECESSITIES, as such the providers of these products should be able to make EXTENSIVE SUPER NORMAL PROFIT from such in-demand INELASTIC GOODS, however... 

-Why is it that you rarely ever see any competition in these markets?-

-Surely these large profits should attract rivals, right?- 

-Why are they almost always exclusively dominated by one firm?- 

-Even with free entry why don't new firms ever try to enter?-

-What is the barrier to entry?-

• A NATURAL MONOPOLY is 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.​

• A firm can experience economies of scale when it expands production, and the level of output at which these average costs are at their lowest is known as the MINIMUM EFFICIENT SCALE.

• SOME FIRMS REQUIRE A VERY LARGE LEVEL OF OUTPUT TO REACH THIS SCALE, and this level of output can be enough to satisfy the entire market. In other words, their average cost curve is falling over the entire range of market demand.

• So if one of these types of firms were to be first into an industry and produce at a level that constitutes 51% or more of the market demand they will be able to attain a lower average cost than any potential entrants, meaning it is unlikely that a second firm would try to enter and compete, as if they did they would not be able to get their average costs as low as the first firm even if they had 49% of the market, thus firm A could charge a price of P=AC and undercut the other firm.

• Imagine you were the first to open a gym in your local area, which has a population of about 5,000, or which 20% are likely to be 

• Due to the nature of the business, before you allow one customer in you need to purchase a large amount of fitness equipment (fixed cost).

• Even when operating the marginal cost of each member is almost zero as the variable costs incurred are minimal.

• Hence as you accept more memberships the average fixed costs continue to fall at a higher rate than marginal costs will ever rise, meaning overall average total costs are falling for each membership until you have a full gym.

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•  Given that the variable costs (receptionist and cleaner etc) are very small relative to your fixed costs, as you accept more and more members the actual average total cost per member falls However, once you have made these purchases the 

• Given the industry demand curve Bob realises that he needs around 2/3rds on the entire customer base in order to reach his profit maximising level of output.

• In order to ever earn enough to cover the average cost of providing membership Bob needs all 500 consumers to join his gym, this way his average costs will be below his price.

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• As we know the profit-maximizing level of output occurs when MC=MR, in order to increase members you need to lower your price, so MR gradually falls, however as the major portion of your average costs are fixed costs which continually fall as the output level rises your AC and MC only start to rise at a level of output way beyond the 500 members.

• We can say that this gym can satisfy the entire market when AC is still falling. They can offer a super low price to the entire customer base, yay!

• Will competition lower the price even further? Well a regular monopoly that doesn't experience falling AC over such a 

• let's imagine a rival gym opens with identical costs and takes half the customers. Now 2 things can happen

• The fall in demand could mean that there exists no level output at which the firm will be able to make even normal profit, which goes for the rival too, hence

• The above definition basically said 'ONE FIRM IS BETTER THAN TWO OR MORE', which implies that COMPETITION IS UNDESIRABLE, but in general, COMPETITION IS ENCOURAGED as we have seen that in perfect competition each firm is always productively and allocatively efficient in the long run, whereas monopolies aren't. 

• HOWEVER thanks to SIGNIFICANT ECONOMIES OF SCALE and LOWER AVERAGE COSTS, it is still possible for a SINGLE-FIRM INDUSTRY to be INEFFICIENT yet still be ABLE TO SELL A GREATER QUANTITY at a LOWER PRICE than a more competitive industry. 

• "The BENEFITS of COMPETITION and EFFICIENCY can be OUTWEIGHED by the BENEFITS of ECONOMIES OF SCALE in TERMS of FINDING the LOWEST COST PRODUCER"

• IF WE KNEW THAT THE ENTIRE MARKET COULD BE SATISFIED BY A SINGLE FIRM AT A LOWER ATC THAN IF THERE WERE MANY COMPETING FIRMS, WOULDN'T IT BE IN THE BEST INTEREST OF SOCIETY FOR THE GOV'T TO ALLOW THEM TO DO SO AND THEN TELL THEM TO LOWER THEIR PRICES SO THAT THEY EARN ONLY NORMAL PROFIT?

• The HUGE START-UP COSTS clearly discourage competition as the risk of failure is far too high.

• In addition, these HIGH START-UP COSTS CAN ONLY BE COVERED IF THE FIRM HAS COMPLETE MARKET SHARE, meaning that were another firm to enter and the market divided the revenue would be insufficient for both to turn a profit, hence no firm will attempt to enter.

• Finally, the first firm to enter has already established such extensive ECONOMIES OF SCALE that they could easily use predatory pricing to prevent any other firm from entering.

• 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.

• Consider a power company at the dawn of the Electric Age. They build a power plant and power lines to carry electricity throughout town to their wealthy customers. 

• One day, Bob the Barrister decides he wants electricity, too, so he calls the power company, which drives out, connects Bob’s house to the grid, and begins charging Bob for the electricity. 

• Here’s the magic: by selling more products the power company’s costs actually go down.  See, it was already producing the electricity that Bob just purchased because that’s mostly how generators work – they produce a certain amount of electricity, whether it gets used or not.  It’s just that, until Bob signed up, that electricity was going to waste.  Now Bob is paying for it.  

• The power company also already had most of the infrastructure to move Bob’s electricity the five miles from the power plant to Bob’s house.  Now Bob is helping pay for that infrastructure, too.  The only added cost from Bob signing up with the power company was a single short cable and an hour or so of labor – which, from the company’s perspective, is a very low cost indeed, and is more than offset by the savings Bob’s membership brings.  

• In fact, the more product the power company sells, the lower their average cost goes.  In theory, they’d be able to return those savings to the consumer, lowering the price of electricity for all their customers.