transport economics - natural monopoly argument

Introduction to natural monopolies

A natural monopoly occurs in industries like railways that require a national infrastructure because fixed costs make up a large proportion of total costs.

There are significant opportunities for technical economies of scale.

Minimum efficient scale (MES) is the level of output needed to achieve technical efficiency i.e. producing at lowest unit cost.

In natural monopoly industries, MES level of output is so high a proportion of total market demand that only one firm to fully exploit the potential economies of scale available in the industry.

For a natural monopoly, regulated monopoly where a government appointed regulator ensures monopoly power is not abused, is the best solution.

Unregulated monopolies have the freedom to set profit maximising (or loss minimising) price and output.

To avoid abuse of monopoly power the government can:

· Appoint a regulator with powers to

* Cap price increases
* Introduce competition
* Monitor service quality and penalise poor performance or

· Ensure a monopoly is regionally divided, allowing performance comparison between different areas i.e. yardstick competition –used by British Rail when train track and operators were a nationalised industry.

Monopoly may be the best market structure where:

· There is the potential for significant economies of scale i.e. one large firm can produce at lower unit cost than many small firms.

· Only monopolies can generate sufficient profits to enable large-scale high cost Research & Development (R&D).

· Domestic monopolies can compete internationally more easily than small firms.

IMPORTANT

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