No Such Thing as a Free Lunch: Principles of Economics (Part 65)

“People.. were poor not because they were stupid or lazy. They worked all day long, doing complex physical tasks. They were poor because the financial institution in the country did not help them widen their economic base.”

― Muhammad Yunus, Banker to the Poor: Micro-Lending and the Battle Against World Poverty

Monopoly and Antitrust Policy

(Part H) 

by

Charles Lamson

A Natural Monopoly

In comparing monopoly and competition, we assumed that there were constant returns to scale. When this is the case, there is no technological reason to have big firms instead of small firms. In some industries, however, there are technological economies of scale so large that it makes sense to have just one firm. Examples are rare, but public utilities---the electric company or the local telephone company, for example---are among them. A firm that realizes such large economies of scale is called a natural monopoly.

Although Figure 11 presents an exaggerated picture, it does serve to illustrate our point. One large-scale plant (scale 2) can produce 500,000 units of output at an average unit cost of $1. If the industry were restructured into five firms, each producing on a smaller scale (scale 1), the industry could produce the same amount, but average unit cost would be five times as high ($5). Consumers thus see a considerable gain when economies of scale are realized.

The critical point here is that economies of scale must be realized at a scale that is close to total demand in the market.

Notice in Figure 11 that the long-run average cost curve continues to decline almost until it hits the market demand curve. If at a price of $1 market demand is 5 million units of output, there would be no reason to have only one firm in the industry. Ten firms could each produce 500,000 units, and each could reap the full benefits of the available economies of scale.

Do natural monopolies still exist?

The classic examples of natural monopolies over the years have been public utilities: the telephone company, the electric company, and the gas company. The basic idea was that huge fixed costs to develop transmission lines and distribution pipes meant large economies of scale. It also made no sense to have five electric companies all running wires down every street.

Until very recently, state governments have allowed public utility companies to exist as monopolies subject to tight regulation of prices. Today everything is changing. The long-distance telephone service market has been fiercely competitive since AT&T was broken up by the courts in 1982. Even the local telephone service is moving toward competition, even though slowly.

Electricity and natural gas are not far behind. California was the first state to allow utility consumers to buy electricity from any supplier; the new regulations took effect in 1998. The trick is to force local utilities to allow low-cost suppliers to transmit power over their lines for a fee. although the trend is clearly away from regulation and toward competition, regulatory commissions are still firmly in control of most state utility markets.

In most cases of government-allowed natural monopolies, there are regulatory agencies in each region to serve as a watchdog for the public. Utilities are typically regulated by the state-run departments of public utilities or public commissions. The U.S. Department of Transportation has broad responsibilities for the safety of travel for railroads while the U.S. Department of Energy is responsible for the oil and natural gas industries.

So far no equivalent agencies in the U.S. have been empowered to similarly regulate tech and information monopolies, nor are they governed as common carriers, though this may be a trend in the future (investopedia.com, Jan 26, 2021).

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 275-276*

end