What is a 'Natural Monopoly'

A natural monopoly is a type of monopoly that exists due to the high fixed or start-up costs of conducting a business in a specific industry. Additionally, natural monopolies can arise in industries that require unique raw materials, technology or 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 utility industry is an excellent example of a natural monopoly. The costs of establishing a mean to produce power and supply it to each household can be substantial. 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 are 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 can 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 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, often 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 the 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. 

Regulating Natural Monopolies

There are instances when the person or corporation behind the natural monopoly takes part in behavior that abuses its position within the market. In cases like these, the market will often call on the government for regulation. Regulation will normally take place if the government feels that the monopoly is acting against the best interest of the public. People calling for regulation will often want to limit any possible abuse of power by the monopoly, to allow competition (in some instances, a possible competitor will ask for government intervention) or to stabilize the market.

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