Principles of Microeconomics / Unit 8 MIC 0708 worked example, 60 to 90 seconds
Is It a Natural Monopoly?
The idea
To decide whether a market is a natural monopoly, place market demand against the long-run average cost curve. Find the output where the two meet. If average cost is still falling at that output, one firm can serve the market at lower cost than two firms splitting it, and the market is a natural monopoly. If average cost has bottomed out and turned up before that output, the market can hold several efficient firms and is not. Check by costing the split.
In practice
Worked example: a town's water demand at a cost-covering price is twenty million gallons a day, and a treatment plant's average cost falls from ten cents a gallon at five million to six cents at twenty million and is still falling at thirty. One plant serves the town at six cents; two plants at ten million each cost eight cents apiece. Natural monopoly. A bakery market of twenty thousand loaves a day, where average cost bottoms at two thousand, holds ten efficient bakeries: not a natural monopoly.
Where people slip
The test is about the market's size against the firm's cost curve, not about how many firms happen to exist; a market with one firm today may not be a natural monopoly, and a natural monopoly may be temporarily contested. And the curve is the long-run curve; short-run economies from a single plant do not settle the question.
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