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Natural monopoly: Explanation | ||
All industries have costs associated with entering them. Often, a large portion of these costs is required for investment. Larger industries, like utilities, require enormous initial investment. This barrier to entry reduces the number of possible entrants into the industry regardless of the earning of the corporations within. Natural monopolies arise where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual or potential competitors; this tends to be the case in industries where fixed costs predominate, creating economies of scale which are large in relation to the size of the market - examples include water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines), therefore it is unlikely that a potential competitor would be willing to make the capital investment needed to even enter the monopolists market. Companies that grow to take advantage of economies of scale often run into problems of bureaucracy; these factors interact to produce an "ideal" size for a company, at which the company's average cost of production is minimized. If that ideal size is large enough to supply the whole market, then that market is a natural monopoly. A further discussion and understanding requires more microeconomics...Two different types of cost are important in microeconomics, marginal cost, and fixed cost. The marginal cost is the cost to the company of serving one more customer. In an industry where a natural monopoly does not exist, the vast majority of industry, the marginal cost decreases with economies of scale, then increases as the company has growing pains (overworking its employees, bureaucracy, inefficiencies, etc.) Along with this, the average cost of its products will decrease and then increase again. A natural monopoly has a very different cost structure. A natural monopoly has a high fixed cost for a product that does not depend on output, but its marginal cost of producing one more good is roughly constant, and small. A firm with high fixed costs will require a large number of customers in order to retrieve a meaningful return on their initial investment. This is where economies of scale become important. Since each firm has large initial costs, as the firm gains market share and increases its output the fixed cost (what they initially invested) is divided among a larger number of customers. Therefore, in industries with large initial investment requirements, average total cost declines as output increases over a much larger range of output levels. Once a natural monopoly has been established because of the large initial cost and that, according to the rule of economies of scale, the larger corporation (to a point) has lower average cost and therefore a huge advantage. With this knowledge, no firms attempt to enter the industry and an oligopoly or monopoly develops. A natural monopoly and a monopoly are not the same concept. A natural monopoly describes a firm's cost structure (high fixed cost, extremely low constant marginal cost). A monopoly describes market share and market power; the two are not synonymous. Copyright 2008 - France BtoB from Wikipédia
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