A natural monopoly is a market that is controlled by one firm. This one firm supplies all consumer demand in the market. There are no other competitors within the market. A natural monopoly creates high barriers to entry and generally operates at a large scale. For those two reasons, competitors are not able to enter the market. By the time any competitors come along, the one firm has already taken virtually all consumer demand, built out an elaborate infrastructure for delivering its services, and has become regulated by the government.
Barriers to entry come in the form of high fixed costs. These costs are a result of the massive infrastructure needed to create a natural monopoly. For example, utility companies such as electric companies must build miles and miles of power lines and substations. Railroads must do the same for rail tracks and train cars. Gas and oil companies must build out pipelines and refineries.
For a natural monopoly to recoup those high fixed costs, it must operate on a large scale. Operating on a large scale doesn’t mean the natural monopoly is the only company supplying some specific service or product. One electric company may supply the northeast region of the U.S. while a different one supplies the northwest. Both are natural monopolies within their own region and are different utility companies that do not compete.
To ensure that natural monopolies do not take advantage of consumers, they are regulated by the government. This is the case for utility companies such as electric and water, railroads, and gas and oil companies. Without competitors to offer choices, the government is the only option to ensure that a quality product at a reasonable price is delivered to consumers.
Just because a company is a natural monopoly doesn’t mean it will be profitable. In fact, many natural monopolies are not. But because the natural monopoly provides an essential service (i.e., electricity or water) and possesses the required infrastructure to deliver that service, the government will often subsidize the firm’s operations. These firms may also sell bonds to help fund operations.
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