a) Explain what is meant by a natural monopoly (10)

A natural monopoly is a type of monopoly characterised by non artificial barriers to entry, usually in the form of high overhead costs (such capital costs or equipment costs). This means that such industries have significant amount of economies of scale and by nature, would be more beneficial if only 1 firm existed and is able to spread the huge costs over a large range of output it produces. We say that the minimum efficient scale occurs at a high level of output. That said, the average cost for such a firm is downward sloping over a large range of output, suggesting that as more output is produced, the cost per unit decreases. So its better to have one firm in this market rather than multiple firms (like in an oligopoly or PC)

With reference to diagram; such industry usually have very high average costs, like water or transport companies. So there is significant EOS and having a monopoly is more beneficial. The natural monopoly is able to reap EOS as compared to PC and Oligopoly. The average cost is much lower since it is spread over large range of output.

Hence, natural monopoly might incur lower cost and charge lower prices to consumers in such industries. Examples are usually the cases of telecommunications and utilities industry, where the costs to set up the infrastructure are restrictively high. In such events, the minimum scale for the firm to be efficient occurs at a high level of output and society benefits from having only one firm

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