When dealing with a natural monopoly, the typical policy actions may involve implementing strict price regulations to control what the firm can charge, or in certain situations, transferring the firm to public ownership.

Policy Responses to Natural Monopolies

Domestic utilities such as those providing water, electricity, or gas are prime examples of industries prone to natural monopolies. These sectors are characterized by extremely high fixed costs related to building and maintaining their supply networks. Because of these high initial costs, the average cost of production per unit is very high unless the firm operates at a large scale, which often leads to a single provider being the most cost-efficient arrangement for the entire market.

Natural Monopolies in Public Utilities

To apply the concepts learned about natural monopolies, find a real-world example of a firm or industry in your own country that operates as one. You can use an example mentioned in this section or identify a new one. Utilize internet research to explain the specific reasons and conditions that led to the establishment of this natural monopoly.

Activity: Identifying and Analyzing a Natural Monopoly

A natural monopoly occurs in a production process where the average cost curve slopes downward sufficiently, even in the long run, allowing a single firm to supply the entire market at a lower average cost than two or more firms could. This significant cost advantage for a single large-scale producer makes it impossible for competition to be sustained in the market.

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A monopoly, literally meaning a 'single seller,' defines a market where a single firm is the exclusive provider of a product without close substitutes. Economists also use this term for situations where a good or service is somewhat unique. In extreme cases, a monopolist confronts no competition and no prospect of new firms entering the market. Monopolies can arise from various factors, including natural market conditions, anti-competitive actions, or government protection through grants like exclusive trading rights.

Monopoly

Falling average cost is a phenomenon where the average cost per unit of production decreases as the output quantity increases. This typically occurs when a firm has significant fixed costs, as these costs are distributed over a larger number of units. Graphically, this is represented by a downward-sloping average cost curve.

Falling Average Cost

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

In *The Wealth of Nations*, Adam Smith highlighted collusion as a key failing of the market system. He famously wrote, 'People in the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public; or in some contrivance to raise prices.' This illustrates his view that sellers often conspire to avoid competition and manipulate prices for their own gain. Smith also strongly condemned government-protected monopolies, using the British East India Company as an example of an entity that distorted the free market and harmed consumers.

Monopolies and Collusion in *The Wealth of Nations*

Which of the following best describes a monopoly?

What is one potential negative effect of a monopoly on consumers?

How can a monopoly negatively impact market competition?

Which of the following is a reason why monopolies can form naturally?

Natural Monopoly

In the 19th century, economist Augustin Cournot analyzed a case of monopoly using the example of a mineral spring with unique health-giving properties. He described how the owner of such a unique resource acts as a monopolist, the sole seller of the product. Cournot showed that this uniqueness allows the owner to set a price above the cost of production, demonstrating how a monopoly is established through control of a singular product.

Cournot's Analysis of a Monopoly on a Unique Mineral Spring

A hypothetical example of an extreme monopoly is a single shop on a remote island. In this scenario, the shop operates as the sole seller of goods, facing no competition and no threat of new rivals entering the market.

Monopoly on a Remote Island

A historical example of government-created monopolies can be seen in the actions of colonial powers who granted exclusive trading rights to specific companies, such as the Dutch and British East India Companies. While these companies were given monopoly control over trade, in practice they still faced some competition from other traders in the East Indies.

Monopoly Rights of the Dutch and British East India Companies

A historical example of a long-term, government-controlled monopoly is the Danish king's exclusive control over trade with the Faroe Islands, which lasted for two hundred years. For much of this period, there was only a single shop operating on the islands.

Danish Monopoly on Trade with the Faroe Islands

Even when a firm is the only seller of a specific product, creating a monopoly in a niche market, it often still faces competition from rivals that offer similar or substitute products. This prevents the niche monopolist from acting with the same level of market power as a pure monopolist with no close substitutes.

Competition from Similar Products in Niche Monopolies

In the 1970s, Parker Brothers, the marketer of the profitable 'Monopoly' board game, spent years fighting in court to protect its monopoly. The company sued economics professor Ralph Anspach to stop the sale of his 'Anti-Monopoly' game. Anspach argued that Parker Brothers didn't have exclusive rights to the name. The court initially sided with Anspach, leading to the release of several competing versions of Monopoly. However, after a legal change in 1984, Parker Brothers successfully established its trademark rights, making 'Monopoly' a protected brand once more. [1, 5]

The Legal Battle Over the 'Monopoly' Trademark

When a firm operates with a cost structure that includes both fixed costs and a constant marginal cost, its average cost per unit of output will decrease as the total quantity produced increases. This occurs because the fixed costs are distributed over a larger number of units, causing the average cost to fall.

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