Answer to Question #49782 in Microeconomics for mj

Question

Sketch the graph of the ATC and the demand curve for a natural monopoly. Briefly explain how this graph shows that a monopoly will result as opposed to the demand being fulfilled by numerous smaller firms.

Answer 1

According to a strict academic definition, a monopoly is a market containing a single firm. In such instances where a single firm holds monopoly power, the company will typically be forced to divest its assets. A natural monopoly is an organization that experiences increasing returns to scale over the relevant range of output and relatively high fixed costs. A natural monopoly occurs where the average cost of production "declines throughout the relevant range of product demand". The relevant range of product demand is where the average cost curve is below the demand curve. When this situation occurs, it is always cheaper for one large company to supply the market than multiple smaller companies; in fact, absent government intervention in such markets, will naturally evolve into a monopoly. An early market entrant that takes advantage of the cost structure and can expand rapidly can exclude smaller companies from entering and can drive or buy out other companies. A natural monopoly suffers from the same inefficiencies as any other monopoly. Left to its own devices, a profit-seeking natural monopoly will produce where marginal revenue equals marginal costs. Regulation of natural monopolies is problematic.