A natural monopoly occurs when just one company is the most productive in an industry. It frequently happens in sectors where capital costs predominate, generating enormous scale economies relative to market size. In a natural monopoly, it is unfeasible to have more than one company producing the good, since fixed costs are usually very high. An example of a natural monopoly is power and water services.
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Natural monopoly was defined by William Baumol as an industry in which multi-firm production is more costly than production by a monopoly.
What is Natural Monopoly?
A natural monopoly often occurs due to high startup costs or considerable economies of scale associated with conducting business in a particular industry, both of which can create significant barriers to entry for potential competitors. A business with a natural monopoly could be the sole supplier of a good or service in a sector or region. Industries that depend on specialised technology, raw materials, or other elements may become natural monopolies.
A market with a natural monopoly is one whose size allows a single vendor to supply the output. A natural monopolist can generate all of the market's products for less money than it would cost if there were several competing businesses.
A natural monopoly develops when a company experiences significant economies of scale in its manufacturing process. Businesses like iron ore or copper mining have substantial upfront fixed costs, and these industries can benefit greatly from economies of scale. A seasoned professional in the field has a clear advantage over a new company attempting to enter the market. The old company (natural monopolist) can supply the entire market at a price significantly lower than the new company would have to charge to stay in business.
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Understanding Natural Monopoly
Natural monopolies can also develop when one company serves the market considerably more effectively than many other companies. One example could be of distributing electricity. It makes little sense to install a second, redundant grid to compete once one grid has been set up to provide electric power to all of the residences in a neighbourhood. The transmission of electricity is a good illustration of this.
Without engaging in any unethical commercial tactics that can restrict competition, a natural monopoly develops into one over time as a result of market conditions. Some monopolies engage in cooperation, mergers, acquisitions, and aggressive takeovers to obtain an unfair advantage. A collision could occur when two rival businesses work together to fix or raise prices to acquire an unfair competitive advantage.
Characteristics of Natural Monopoly
Characteristics of natural monopoly are:
- This monopoly typically exhibits the trait of a steeply falling long-run average.
- They naturally arise in a free market since rivals cannot compete with them, whether voluntarily or unwillingly. Natural economic forces restrict new businesses from entering the market.
- Their marginal cost curves also show a sharp reduction.
- It makes sense for one company to serve the entire market. Competition is not a good thing.
- As a result, there is only room for one company to enter the market and establish a monopoly by fully utilizing its scale of economies and product supply.
- Because of economies of scale, businesses have significant fixed costs. They also have a high initial fixed cost and greater maintenance costs. These businesses must serve the entire market due to the high expense.
- Nevertheless, their marginal costs to produce an additional unit of products or services are lower.
- Some businesses may only have a monopoly in a particular nation or area rather than globally.
When does a Natural Monopoly Occur?
A natural monopoly is a type of monopoly that develops in a specific industry as a result of prohibitive startup costs or significant economies of scale. A business with a natural monopoly could be the sole provider of a good or service in a given market or region.
A natural monopoly develops in an industry when high infrastructure costs and other barriers, about the size of the market, offer the largest supplier in the sector, frequently the first supplier in a market, a significant competitive advantage over possible rivals.
Natural monopolies are permitted when one firm can provide a good or service for less money than any potential rival, but they are frequently tightly controlled to safeguard consumers.
As the term suggests, a natural monopoly develops over time due to market circumstances and does not involve any unethical commercial actions that would impede competition. Two rivals can collude to set or raise prices to gain an unfair competitive advantage.
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Types of Natural Monopoly
Nevertheless, there are two different types of natural monopolies.
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Simple Natural Monopoly
First, is the Simple natural monopoly in which a company creates a "moat," or protective wall, around its operations by taking advantage of the high entry barriers to a market. A significant amount of capital or cash is frequently required to buy fixed assets, tangible assets required for a business to run, contributing to the high entry barriers.
Manufacturing facilities, cutting-edge machinery, and equipment are all fixed assets that may make it difficult for a new business to enter a market due to their high costs.
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State Natural Monopoly
Second, it is the state natural monopoly where a single huge manufacturer can meet the entire market demand since large-scale manufacturing is much more beneficial than small-scale production. Since their higher costs, small producers can never compete with larger, less expensive ones.
In this case, the natural monopoly of one large producer also results in the most cost-effective method of producing the goods at issue. The first-mover advantage, the benefits of centralising knowledge and decision-making, network effects, or simple first-mover advantage may all lead to this kind of natural monopoly rather than large-scale fixed assets or investments.
Examples of Natural Monopoly
When just one company is the most productive in an industry, it results in a natural monopoly. Natural monopolies generally have extremely high fixed costs, which implies that it would be impractical for several companies to produce the good.
In their particular marketplaces, many of the biggest energy corporations in the world enjoy natural monopolies. Governments typically create natural monopolies to supply needs like water and energy, and utilities have substantial startup costs and demand significant infrastructure expenditures. Because of this, governments may easily retain natural monopolies for utilities. But with the recent advancements in affordable nuclear energy, this could soon change. Markets that face natural monopolies in one way or another include those in the telecom, internet, and national military sectors.
- Manufacturing of aeroplanes is currently a duopoly; thus, it is not a natural monopoly, but it is quite close. Manufacturing aeroplanes have very high fixed costs, but two major producers can sustain them due to the worldwide market size.
- Digital platforms are another example of a natural monopoly. In some cities, a service like Uber has become standard for using an app to book a private cab. However, there aren't many fixed expenses. The dominant company gains from network economies, better information, and lower average prices.
- Bus services at a specific location. Within a town, one bus company makes the most sense. Having two bus companies vying for the same route and providing the same peak and off-peak services, even on a busy route between two towns, may not be efficient. However, one business can avoid:
- Identical services
- Congestion during peak hours
- Insufficient demand during off-peak hours
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Enforced Natural Monopolies
Governments frequently create natural monopolies to regulate particular markets rather than profit from them. For instance, during election season, several political parties promise voters that they will cut the cost of basic commodities. Using a government-owned natural monopolist to fix the price below the free-market price is a reasonably simple approach. For instance, India previously had given the public sectors a monopoly cooking distribution.
It is also possible to direct investment within an economy by creating natural monopolies. For instance, natural monopolies hinder private capitalists from making investments in some heavy sectors. Some governments prohibit private foreign investment in their country's heavy industries, including those that produce iron, coal, copper, and nuclear fuel.
Conclusion:
Generally, natural monopolies exist due to high startup costs or powerful economies of scale. A company being in natural monopoly might be the sole provider of any particular product/service to its consumers. This blog covered detailed information about the natural monopoly definition, its examples, and its characteristics.
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