Cambridge International as and a level Economics Ebook

Natural monopoly
A natural monopoly is a market situation where a 
monopolist has overwhelming cost advantage. In theory 
this can come about where a monopoly has sole ownership 
of a resource or where past ownership of capital resources 
Output
0
Cost and r
evenue
MC
ATC
AR
Q
MR
P
MC = MR
TR = 
P
×
Q
TC = 
P
1 
×
Q
= Abnormal
profit
Optimum
P
1
Figure 7.19 
The equilibrium of a pure monopoly
170
Cambridge International A Level Economics

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means that it is diffi
cult and extremely expensive for 
competitors to duplicate these installations. It would also 
be extremely wasteful to do so.
Th
e natural monopoly case is one that has consistently 
been put forward in support of public ownership of 
services such as water, gas and electricity. It is also 
applicable to railways and canals. In all of these cases, 
fi xed costs are a very high percentage of total costs. As 
output increases, average fi xed costs will decline off ering 
the prospect of substantial benefi ts to be gained from 
economies of scale. With a canal, for example, long-run 
average costs per vessel using the canal will fall since the 
total costs are spread over an increased number of vessels. 
Th
e same argument applies in the case of rail track.
Figure 7.20
is the usual representation of a natural 
monopoly. It shows a falling long-run average cost curve, 
indicative of continuing economies of scale. A monopoly 
fi rm would set price at 
P
1
, provide 
Q
1
output and earn 
abnormal profi ts. If it behaved like a competitive fi rm, the 
equilibrium position would be where price equals long-run 
marginal cost – price would be lower at 
P
2
, the quantity 
provided higher at 
Q
2
. Th
is is a loss-making position. Th
e 
problem is that this will only happen if the government 
is prepared to subsidise the monopoly on the grounds 
that what it is providing is an essential public service. 
Th
e alternative is for the service to be provided by the 
public sector.
Th
e natural monopoly case is particularly strong in 
the case of railways, canals, piped water supplies and 
electricity. Th
ere is little economic logic in having rival 
companies competing with each other especially as, with 
rail, government subsidies are required to keep the system 
functioning at a social optimum level.