Lesson: How Monopolies Form: Barriers to Entry

Natural Monopoly

Natural Monopoly

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  • A company that makes a new product will seek to have a patent on the product. This allows the company to have a natural monopoly.
  • An example of a natural monopoly product is a pharmaceutical company. When a pharmaceutical company makes a new medication, they get a patent so they have complete control over the new product. Until that patent expires, they own the market. Once the patent expires, other companies can make the same medication in a generic form so consumers have options.
  • Other natural monopolies that provide services are railroads, regional bus services, utilities (gas, electric, water, and power), and plane manufacturing.
  • Natural monopoly companies have a great deal of power over the cost of their products and services. They can raise their prices and the consumer has no other choice for substituting with a different product or service.

Economies of scale can combine with the size of the market to limit competition. The figure below presents a long-run average cost curve for the airplane manufacturing industry. It shows economies of scale up to an output of 8,000 planes per year and a price of P0, then constant returns to scale from 8,000 to 20,000 planes per year, and diseconomies of scale at a quantity of production greater than 20,000 planes per year.  

In this market, the demand curve intersects the long-run average cost (LRAC) curve at its downward-sloping part. A natural monopoly occurs when the quantity demanded is less than the minimum quantity it takes to be at the bottom of the long-run average cost curve.