natural monopolies + monopoly

natural monopolies

occur when it is more efficient to have a single firm supplying the entire market rather than multiple firms

this happens due to huge economies of scale, as a firm grows its costs keep falling

e.g london underground

economies of scale

Economies of scale occur when increasing the scale of production leads to a lower average cost per unit.

In other words → as a firm grows, it spreads its costs more efficiently.

Shown on a cost diagram as the falling part of the Long-Run Average Cost (LRAC) curve.

1. Internal Economies of Scale (within a firm)

When a single firm expands, it reduces average costs due to:

Technical economies → using larger, more efficient machinery.

Purchasing economies → bulk buying inputs at cheaper unit cost.

Managerial economies → hiring specialist managers increases efficiency.

Financial economies → bigger firms get loans at lower interest rates.

Marketing economies → spreading advertising over larger sales output.

Risk-bearing economies → large firms diversify products/markets, spreading risks.

2. External Economies of Scale (across an industry)

When the whole industry expands, all firms benefit:

Improved infrastructure (roads, ports, supply chains).

Skilled labour pool in the area.

Shared suppliers reducing input costs.

Diagram:

LRAC curve is U-shaped.

Downward-sloping part = economies of scale (falling average costs).

Upward-sloping part = diseconomies of scale (rising average costs due to coordination/control problems when firms get "too big").

characteristics of natural monopolies

number of firms : one firm dominates market

product differentiation: homogenous

barriers to entry: high barriers, high fixed costs, legal barriers, economies of scale

profits: SNP in short and long run

price maker

not productive or allocatively efficient

dynamically efficient (long-run) is possible as high profits can be reinvested.

diagram

Axes:

Y-axis: Cost/Price

X-axis: Output (Q)

Curves:

LRAC (Long-Run Average Cost) → downward sloping over the relevant range (economies of scale dominate).

MC (Marginal Cost) → low and flat (because marginal cost of serving one more unit is tiny).

AR = Demand curve → downward sloping (normal demand).

MR → below AR.

In a natural monopoly, the LRAC is always above MC but continues falling as output expands.

The socially efficient point is where P = MC. But here, P < AC, so the firm makes a loss if it charges that price.

If the firm sets price where AR = AC, it covers costs (normal profit), but output is lower than socially efficient.

Left alone, the monopoly will restrict output to where MC = MR (profit maximisation), which gives higher prices, lower output, and supernormal profit.

Government Intervention:

Governments often regulate natural monopolies:

Price regulation → forcing them to set P closer to MC.

Subsidies → covering the gap between AC and MC to allow efficient pricing.

Nationalisation → government ownership to ensure efficiency + universal access.

✅ Exam Tip Phrase:

A natural monopoly exists when a single firm can supply the whole market at lower cost due to significant economies of scale. The LRAC falls continuously, making multiple firms inefficient. Without regulation, natural monopolies restrict output and charge high prices, but government regulation can push output closer to the socially efficient level.

pros

Lower average costs (economies of scale)

A single large firm spreads high fixed costs, reducing LRAC.

Cheaper for consumers compared to many small firms duplicating infrastructure.

Avoids wasteful duplication

No need for multiple networks (e.g. water pipes, electricity cables) which would be inefficient.

Potential for universal service

A single firm can serve the whole market, including rural/less profitable areas.

High government control potential

Easier to regulate one firm than many, ensuring

price caps or quality standards.

Innovation & long-term investment

Monopoly profits can be reinvested in improving infrastructure and service reliability.

cons

❌ Cons of a Natural Monopoly

Higher prices if unregulated

Profit maximisation (MC=MR) leads to higher P, lower Q than socially efficient level.

Allocative inefficiency

Price is often set above marginal cost (P > MC).

Productive inefficiency

Without competition, monopolies may not produce at the lowest point on AC.

X-inefficiency

Lack of competitive pressure → complacency, waste, higher costs than necessary.

Consumer choice limited

Only one supplier = no alternatives for customers.

Risk of regulatory capture

The monopoly may influence regulators to act in its interest instead of consumers.

✅ Exam Tip Phrase:

Natural monopolies benefit from huge economies of scale and can provide lower costs and universal service. However, without regulation, they risk inefficiency, high prices, and poor consumer outcomes.

Do you want me to also make a short exam-style evaluation paragraph (like you'd write in a 25-marker) weighing up whether natural monopolies should be regulated or nationalised?

monopoly

A monopoly is a market structure where one firm dominates the market, >25% market share = monopoly power.

Characeristics

number of firms : one / >25% market share

product differentiation: differentiated

barriers to entry: high barriers to exit and entry

profits: SNP in short and long run

price maker

low productive or allocatively efficient

x-inefficiency

barriers to entry

makes demand inelastic as there is no other choice for consumers this gives them price making power, allowing firms to make SNP in both SR and LR as they become profit maximisers

legal barriers = patents prevents new suppliers entering market

high capital + sunk costs = firms trying to enter new market stopping competition

economies of scale = can be exploited to lower costs which smaller firms wont be able to do

predatory pricing = monopolies can drop prices below other firms

marketing = large marketing budgets creates consumer trust.

efficiencies

lack of allocative efficiency = they are charging about P = MC this is not the lowest price they can allow the most amount of people to access the good.

productively inefficient = not producing at the lowest point of AC curve

dynamically efficient = not likely as they are less likely to reinvest profits to innovate

cons

lack of allocative efficiency- firms are not trying to supply everyone in the market (P=MC)

lack of productive efficiency - firms do not operate at the lowest cost (AC=MC)

X-inefficiency - firms so large managers cannot maximise productivity of each worker and factor input .

prevents technological advancement - no competition = no incentive to innovate and enhance technology - creative destruction- firm are not dynamically efficient and another firm actually overtakes them

diseconomies of scale occur when the company gets too large. Diseconomies of scale causes AC to rise which will pass onto consumers in the form of higher prices, reducing efficiencies and consumer welfare. diseconomies of scale occur when the company gets too large

Managerial inefficiency:

Large monopolies may suffer from poor communication and slow decision-making.

Coordination problems

Difficult to manage thousands of workers/factories → bureaucracy and red tape increase costs.

Worker demotivation

In huge firms, workers feel less connected → productivity falls.

X-inefficiency

With no competition, monopolies may not control costs tightly → waste and complacency.

1. Economies of scale

Large monopolies can spread high fixed costs over more output → lower long-run average costs.

Consumers may benefit from cheaper prices if economies are passed on.

Especially relevant for natural monopolies (utilities, rail, water).

2. Dynamic efficiency

Supernormal profits give monopolies funds for R&D, innovation, new technology, better products.

May lead to long-term gains (e.g. pharmaceuticals, tech firms).

3. Stability and security

Prices are more stable (not constantly changing due to competition).

Provides certainty for investment and consumers.

4. Cross-subsidisation

Monopoly profits from one market/product can be used to support loss-making services (e.g. rural postal services, public transport).

Helps achieve wider social objectives.

5. Global competitiveness

A strong monopoly can compete internationally (e.g. Airbus, Google).

May bring in export revenue and jobs.

6. Natural monopoly efficiency

In industries with huge infrastructure costs, it's cheaper for one firm to provide the service (avoiding duplication of water pipes, power lines, rail tracks).

7. Risk-bearing economies

Large monopolies can diversify across products/markets, reducing business risk.