Monopoly: Question 2

2. Using a diagram, explain the concept of a natural monopoly.

An industry is a natural monopoly if there are only enough economies of scale available in the market to support one firm. In other words, this means that only a very big company who already has all economies of scale can produce the product.

This is due to the extremely high costs that only very big companies can face. Furthermore, it is more efficient when only one single firm produces the product that is being demanded. This can be shown in an example. If there are 8 firms in the market for nuclear power plants and each of those firms produces one nuclear power plant, each firm faces costs of 150 million $ while when there are 2 firms each producing four nuclear power plants, the costs faced by the each firm would only be 40 million $. But when there is only one single firm producing eight nuclear power plants, the costs for this firm are only 40 million. The difference between 1200 million $ (8x 150 million $) and 320 million $ (8x 40 million $) shows the inefficiency of more than one firm operating in such a market. This is the main feature of a natural monopoly. Furthermore, if more than one company would be in such a market, the new firm would take parts of the demand of the firm that was already in the market and thereby shift the demand curve down which would cause a decrease in price for both firms or losses for both.
The control over such natural monopolies by the government is to put a price ceiling. It is put to the point where AC= AR (in this case D) since that's when the firm breaks even. This control is necessary because without it the output the firm would make would be way to low and the price would be too high. This would mean that a lot of people would not be able to afford the product which is most of the time a necessity or to get it because there is not enough produced. But at the set price which is called the fair return price the population can afford the product and the firm is breaking even.