A natural monopoly is exactly what the name suggests.
In other words, it’s when one company controls a market because of unique product, manufacturing, or market conditions. These barriers to entry can include high start up costs, high fixed costs, difficulty in obtaining the needed raw materials, as well as many other things.
Railways are often considered a typical example of a natural monopoly. Regulators can cap prices or the level of return gained. If public utilities are privately owned, as in the UK since privatisation during the 1980s, they usually have their own special regulator to ensure that they do not exploit their monopoly status.Įxamples of regulators include Ofgem, the energy regulator, and Ofcom, the telecoms and media regulator. Natural monopolies are common in markets for ‘essential services’ that require an expensive infrastructure to deliver the good or service, such as in the cases of water supply, electricity, and gas, and other industries known as public utilities.īecause there is the potential to exploit monopoly power, governments tend to nationalise or heavily regulate them. When MES can only be achieved when one firm has exploited the majority of economies of scale available, then no more firms can enter the market. If MES is only achieved when output is relatively high, it is likely that few firms will be able to compete in the market. Minimum efficient scale (MES) is the lowest level of output at which all scale economies are exploited. With natural monopolies, economies of scale are very significant so that minimum efficient scale is not reached until the firm has become very large in relation to the total size of the market. It may be more efficient to allow only one firm to supply to the market because allowing competition would mean a wasteful duplication of resources. The efficiency loss to society would exist if the new entrant had to duplicate all the fixed factors – that is, the infrastructure. In the case of natural monopolies, trying to increase competition by encouraging new entrants into the market creates a potential loss of efficiency.