![]() Therefore, it makes sense for there to only be one firm in each city – it would be economically inefficient to have two competing natural gas distribution grids, just as it would be inefficient to have two redundant electricity grids, or two telephone grids, or sets of water distribution pipes, and so on. Each firm would have to spend the same amount of money, but have half of the size of market to try to recover their costs from. Each firm would have to spend a lot of money, but then compete for the same size of customer base. If there was to be competition between different natural gas suppliers, then there would have to be two sets of distribution pipes. Now, imagine that this was a competitive market. This represents a pretty massive capital (or fixed) cost component, but the cost of servicing a new customer is very small compared to that. For example, if you have a natural gas distributorship, you have to build a large network of distribution pipes and valves covering an entire city. These industries are typically referred to as “utilities,” and they require the development of large infrastructures to serve the customer base. Some typical industries would be the delivery of telephone services, or natural gas, or electricity, or cable television. ![]() This means that to be the first entrant, you have to spend a large amount on fixed costs, but the cost of servicing an extra customer is very low. What types of industries have this type of structure? Well, generally, industries that have very high capital costs, and comparatively low variable costs. This is why declining-marginal-cost industries are called natural monopolies. In this case, it is efficient, or “natural,” for there to only be one firm in the market. This means that having two firms in a market ends up with the firms having to charge a higher price than if only one firm existed. We can assume the Q 2 = 0.5 Q 1, and that each of the two firms supplies Q 2 of the good in question.ĭo you see the problem? If we have one firm only, the marginal cost of supply is P 1, which is lower than the duopoly price, P 2. This corresponds to the equilibrium E 2 on the above diagram, which gives us quantity Q 2 and price P 2. We can assume, for simplicity, that each seller in the market has exactly half of the market. Now, let’s imagine that this was a duopoly market, where there are two suppliers. Let’s assume this is a monopoly equilibrium, where Q 1 represents the entire size of the market – it represents everybody who wants to buy the good. Given the downward sloping supply curve, and ignoring the demand curve for a minute, let’s say we have an equilibrium at point E 1, which corresponds to quantity Q 1, and gives us price P 1. Instead, it is a characteristic of a certain type of market - one with high capital costs and low marginal costs. I should comment here that the textbook lumps natural monopoly in with other barriers to entry, and while it can potentially be thought of as a barrier, it is not one that is created by a market-power-seeking firm. Posner © Penn State is licensed under CC BY-NC-SA 4.0 The following diagram can help to illustrate just why.Ĭredit: B. This is called a “natural monopoly” because it is economically efficient for there to only be one supplier. ![]() In such a case, the marginal cost curve, and thus, the supply curve, will be downward sloping or flat over the relevant range of production. There are cases where the marginal cost, that is, the cost of satisfying one more customer, is lower than the cost of servicing the previous customer. Simply put, we can reasonably expect supply curves to be upward sloping.īut sometimes, they are not. That is, if we want to open a factory to make more detergent, we will have to hire workers, and assuming that we have something close to full employment, to get those workers, you will have to offer them higher wages than what they are receiving from their existing jobs. This is a reasonable assumption to make, because as production of some good increases, the cost will increase because we have to compete with other goods for consumption of the inputs. For this situation to be able to occur, we make the assumption of upward-sloping supply (marginal cost) curves. ![]() In a competitive market, we expect firms to compete with each other until the point where marginal cost increases to match the demand curve at the equilibrium point. Please reread "Characteristics of a Monopoly" on pages 210-213 in Chapter 11 for this section.
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