Lesson preview · Monopoly Basics
Natural Monopoly
~5 min · Free to read
Of the four sources of monopoly power, the natural monopoly is the strangest: it’s the one case where having a single producer genuinely is cheaper than having several. It arises when production technology bundles a huge fixed cost with a low marginal cost. Think utilities — power grids, water mains, railway track. One firm spreading that fixed cost across every customer in the market ends up with a lower per-unit cost than two firms each serving half could. You wouldn’t want three separate water pipes running to every house.
Tip
Standard Oil's price collapse — scale economies in action
Refining oil in the 1860s meant building furnaces, stills, barrel works, and tank yards — most of the cost was fixed. As Standard Oil scaled, those fixed costs got spread over hugely more gallons, and refining cost per gallon collapsed. The retail price of kerosene followed:
- 1865: about 58 cents/gallon
- 1870: about 26 cents/gallon (Standard Oil forming)
- 1880: about 9 cents/gallon
- 1890s: about 6 cents/gallon
A roughly tenfold drop in 30 years. Part of that was predatory pricing aimed at rivals — but the durable, technological part was pure natural-monopoly mechanics: bigger plant, fixed costs amortised over more output, lower ATC. That’s the same shape of curve you’ll drag below.
A natural monopoly exists when one firm’s ATC is still falling at the quantity that satisfies total market demand
Worked Example
A water utility has fixed costs of 10 million dollars and marginal cost of 0.01 dollars per gallon. The city needs 500 million gallons/year. Would it be more efficient to have one provider or two?
Check yourself · no marks
If a natural monopoly is genuinely cheaper than two firms, why do governments regulate utility prices instead of just leaving them alone?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Practice · 1 / 4
A natural monopoly exists when:
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