NATURAL MONOPOLY: CHARACTERISTICS AND EXAMPLES - ECONOMY - 2025

A natural monopoly is a type of monopoly that exists due to existing barriers to conducting business in a specific industry, such as high initial capital costs or powerful economies of scale that are large relative to the size of the market.

A company with a natural monopoly could be the only supplier, or the only product or service in an industry or geographic location. Natural monopolies can arise in industries that require unique raw materials or technologies, or similar factors, to operate.

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From a regulatory point of view, a monopoly exists when a single company controls more than 25% of a specific market. For example, the De Beers company has a monopoly in the diamond industry.

The natural monopoly is a particular variant of this situation. It happens when it makes the most sense, in terms of efficiency, that only one company exists in a given sector.

This type of monopoly was recognized in the early 19th century as a possible market failure. John Stuart Mill supported the existence of government regulations to make it serve as a public good.

characteristics

Market conditions

As its name implies, a company over time becomes a natural monopoly due to market conditions, without the need to use unfair commercial practices that can extinguish competition. It can happen in two ways:

High barriers to entry

It happens when a company takes advantage of an industry's high barriers to entry to create a protective wall around its business operations.

High barriers to entry are often due to the large amount of capital required to purchase the physical assets that a business needs to operate.

Manufacturing plants, machinery and specialized equipment are fixed assets that could prevent a new company from entering an industry due to their high costs.

Large-scale production

It happens when it is much more efficient to produce on a large scale than on a small scale. Therefore, a single large producer is sufficient to satisfy the available market demand.

Because their costs are higher, small-scale producers will never be able to compete with the larger, lower-cost producer. In this case, the natural monopoly of the single large producer is also the most economically efficient way of producing the good in question.

This natural monopoly results from the advantage of having been the first to move or increased profits by centralizing information and decision-making.

Monopoly allowed

Natural monopolies are allowed when a single company can supply a product or service at a lower cost than any other potential competitor, and in a volume that can serve an entire market.

Because natural monopolies efficiently use the limited resources of an industry to offer consumers the lowest unit price, in many situations it is advantageous to have a natural monopoly.

The rail industry is sponsored by the government, which means that it allows its natural monopoly by helping it prosper, by being more efficient and in the best interest of the public.

However, the fact that a company operates as a natural monopoly does not mean that it is the only company in the industry. The company could have a monopoly in only one region of the country.

For example, cable companies are often regionally based, although there has been consolidation in the industry, creating national companies.

Regulations

Companies that have a natural monopoly may sometimes want to use this benefit by exerting their power in a detrimental way, not only by inflating prices, but by restricting the supply of a product.

Therefore, regulations on natural monopolies are often established to protect the public from any misuse that may be made.

In general, these companies are required to allow open access to their services, without restricting their supply or discriminating between customers. In return, they are allowed to operate as a monopoly, providing protection from liability for possible misuse by customers.

For example, fixed telephone companies are obliged to offer telephone service to all households within their territory, without discriminating on the basis of the content of people's telephone conversations.

In return, they are not liable if their customers abuse the service by making prank phone calls.

Examples

Utility industry

For example, the utility industry is a natural monopoly. Utility monopolies provide water, sewer services, electricity, and energy, such as natural gas and oil, to cities and towns across the country.

The start-up costs associated with establishing utility plants and distributing their products are considerable. As a result, the cost of capital is a strong deterrent to potential competitors.

Furthermore, society can benefit from having public services such as natural monopolies. It would not be feasible to have multiple utility companies, as there would have to be multiple distribution networks for each competitor.

Electricity requires networks and cables, water and gas services require pipes. In none of these cases is it particularly feasible to have multiple utility providers in an industry.

Because it is economically reasonable for utilities to function as natural monopolies, governments allow them to exist. However, this industry is heavily regulated to ensure that consumers get fair prices and adequate services.

Railways

This example is often used as the quintessential model of a natural monopoly.

It just doesn't make much sense to have multiple sets of railroad tracks, stations, etc. for the same purpose. It is too high an investment to be financially practical.

Social networks

More modern examples of natural monopolies include social media platforms, search engines, and online retailing.

Companies like Facebook, Google, and Amazon have created natural monopolies for various online services, due in large part to the advantages of being the first operator, the effects of the network, and the natural economies of scale involved with handling large amounts of data. and information.

Unlike traditional public services, in most countries this type of natural monopoly has so far been practically deregulated.

Aircraft manufacturing

Only two companies in the world build airplanes. Technically, this makes them a "duopoly" - only two companies in one industry.

This is because aircraft manufacturing requires a high income to pay for fixed costs.

References

1. Jim Chappelow (2019). Natural Monopoly. Investopedia. Taken from: investopedia.com.
2. Wikipedia, the free encyclopedia (2019). Natural monopoly. Taken from: en.wikipedia.org.
3. Intelligent Economist (2019). Natural Monopolies. Taken from: intelligenteconomist.com.
4. Tutor2u (2019). Explaining Natural Monopoly. Taken from: tutor2u.net.
5. Economics Online (2019). Natural monopolies. Taken from: economicsonline.co.uk.