What is a natural monopoly?

A natural monopoly occurs in a market where a single firm can produce goods or services at a lower cost than multiple competing firms. This efficiency arises typically due to the extensive infrastructure or fixed costs associated with production that lead to economies of scale. In essence, as the quantity of production increases, the average cost of production decreases, making it more practical for one firm to serve the entire market rather than having multiple firms duplicating the same infrastructure.

For example, utilities like water and electricity often exhibit characteristics of a natural monopoly. These services require large investments in distribution networks, and having multiple providers could lead to inefficient use of resources, higher costs for consumers, and unnecessary overlap in infrastructure. Therefore, it becomes more efficient for one firm to supply the entire market.

This understanding distinguishes a natural monopoly from other market structures, such as perfect competition, where many firms operate, or monopolistic competition, where there are several firms with differentiated products. Additionally, while government regulations can affect monopolies, they are not an inherent characteristic of a natural monopoly itself.