Dilemma of Natural Monopoly

In some industries, average costs decline as output expands, and a single large firm has the potential to produce total industry output more efficiently than any group of smaller producers. Demand equals supply at a point where the industry long-run average cost curve is still declining. The term natural monopoly describes this situation, because monopoly is a direct result of the superior efficiency of a single large producer.

For example, consider Figure 13.2. Here the firm will produce Q units of output at an average cost of C per unit. Note that this cost level is above the minimum point on the long-run average cost curve, and average costs are still declining. As a monopolist, the firm can earn an economic profit equal to the rectangle PP'C'C, or Q(P - C). Local electric, gas, and water companies are classic examples of natural monopolies, because the duplication of production and distribution facilities would greatly increase costs if more than one firm served a given area.

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