Natural Monopoly

A theoretical market structure in which productive efficiency is guaranteed by a single producer rather than by many because of technical fac tors. Technical factors may impinge on resource avail ability, outlays, and technological advancement. As output increases, the single producer enjoys extensive economies of scale (low per-unit cost), from which con sumers might obtain lower prices.

The marginal cost of producing incremental (additional) units is negligible to such an extent that no other market structure can supply the good more cheaply. A competitive market structure, for example, would gener ate comparatively higher per-unit cost.

The amount of fixed cost necessary for production is a very important precondition for natural monopoly because it constitutes a significant proportion of total cost, which in turn affects per unit cost. The utility, mass transit, and cable television markets require substantial sunk costs to deliver services to consumers.

An efficiency-generated monopoly (natural monopoly) is different from other forms of monopoly. Monopoly may alternatively be generated because of licenses, patents, copyright laws, control over resources, and regulations that prevent others from entering into a particular market.

Although a single-utility company can deliver a prod uct much more efficiently than other firms, the profit-maximizing potential of a monopolistic structure can make it less desirable to charge the fair rate of return or a price that is reasonably above the fair rate (per-unit cost) in order to guarantee retained earnings for invest ment or growth and compensation to investors. In such situations, cost advantage does not automatically trans late into consumer gain. To prevent the exploitation of consumers, some amount of regulation may be desirable, but the idea of regulation poses a dilemma.

If natural monopolies are to be regulated, the regu lated price must be sufficient for them to stay in busi ness, which means that they should be able to cover per unit cost and retain enough earnings for future growth. Since the marginal cost is extremely low, the efficient price will be below per-unit cost. The efficient price is unfavorable except when sufficient subsidy is provided. Governments will have to raise money to subsidize pro duction, which might mean an increase in taxes. Regulation must also take into consideration the right to enjoy ownership of property. In Smyth v. Ames (1898), the U.S. Supreme Court recognized the need to maintain a balance of societal interest and property right (including the reward). For more information, see Schiller (2006) and Smyth v. Ames (1898).