Natural Monopoly (Chain of Analysis)

This short revision video looks at the concept of a natural monopoly and explains how to build good chains of reasoning to score higher analysis marks in an A level microeconomics paper. A natural monopoly does not mean that there is only one business operating in the market. But with a natural monopoly the economies of scale available to the largest firms mean that there is a tendency for one business to dominate the market in the long run.

Text of the Chain of Reasoning on Natural Monopoly

A natural monopoly is a special case where one large business can supply the entire market at a lower unit cost contrasted with multiple providers.

This is because of the nature of costs in a natural monopoly industry. Typically there are very high fixed costs and low marginal costs.

For example, the supply of water or electricity to houses and businesses involves building a big network infrastructure.

As a result, fixed costs are enormous but the marginal cost of adding an extra user is very low.

Therefore, the average total cost will continue to fall as extra users are added to the network. This is an internal economy of scale.

This means thatlong run average cost (LRAC) may fall across all ranges of output. Only one firm might reach the minimum efficient scale.

Exam hint:

Use the natural monopoly argument as a theoretical and practical piece of evaluation for essays relating to the pros and cons of monopoly i.e. if a natural monopoly did not exist in a particular market then it may be the case that there would be a missing market. Furthermore, many natural monopolies operate in the national interest. The quality of service provided makes a big difference to the everyday lives of millions of households and businesses.