What is a 'Natural Monopoly'

A natural monopoly is a type of monopoly that exists as a result of the high fixed costs or startup costs of operating a business in a specific industry. Additionally, natural monopolies can arise in industries that require unique raw materials, technology or other similar factors to operate. Since it is economically sensible to have some monopolies like these, governments allow them to exist but provide regulation, ensuring consumers get a fair deal.

BREAKING DOWN 'Natural Monopoly'

A natural monopoly, like the name implies, is a monopoly that does not arise due to collusion, consolidation or hostile takeovers. Instead, natural monopolies occur when a company takes advantage of an industry's high barriers to entry to create a "moat" or protective wall around its operations.

The utilities industry is a good example of a natural monopoly. The costs of establishing a means to produce power and supply it to each household can be very large. This capital cost is a strong deterrent for possible competitors. Additionally, society can benefit from having a natural monopoly like this because multiple utility companies operating in the same industry overleverage the available resources.

The Positives and Negatives of Natural Monopolies

Natural monopolies occur due to an industry's high cost structure; in most cases, a single firm is able to supply a product or service at a lower cost than any potential competitor, and at a volume that can service an entire market. This makes pure natural monopolies very rare, but they do exist, and most often as a single player in an industry. But just because a company operates as a natural monopoly does not explicitly mean it is the only company in the industry.

Since natural monopolies use an industry's limited resources efficiently to offer the lowest unit price to consumers, it is actually advantageous in many situations to have a natural monopoly. In fact, a successful natural monopoly, such as a railroad company, becomes so efficient it is actually in a government's best interest to help it flourish. Further, oftentimes an industry cannot support two or more major players, and a highly competitive market with unique resources and a high cost structure is unsustainable.

Companies that realize a natural monopoly sometimes exploit the benefits. For example, monopolies can restrict supply of a good or service, thus inflating prices. A railroad company can increase freight prices or increase the prices of passenger tickets since it is the only company offering this type of transportation. If a company takes advantage of a natural monopoly, a government may intervene by enforcing public ownership institution regulations.

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