The first possibility is to leave the natural monopoly alone.

However, we have rounded some of the price values in this table for ease of presentation.) Table 11.3 Regulatory Choices in Dealing with Natural Monopoly (*We obtain total revenue by multiplying price and quantity. Table 11.3 outlines the regulatory choices for dealing with a natural monopoly. Points A, B, C, and F illustrate four of the main choices for regulation. What then is the appropriate competition policy for a natural monopoly? Figure 11.3 illustrates the case of natural monopoly, with a market demand curve that cuts through the downward-sloping portion of the average cost curve. The Choices in Regulating a Natural Monopoly Before the advent of wireless phones, the argument also applied to the idea of many different phone companies, each with its own set of phone wires running through the neighborhood. The same argument applies to the idea of having many competing companies for delivering electricity to homes, each with its own set of wires. Installing four or five identical sets of pipes under a city, one for each water company, so that each household could choose its own water provider, would be terribly costly. It would make little sense to argue that a local water company should be divided into several competing companies, each with its own separate set of pipes and water supplies. Public utilities, the companies that have traditionally provided water and electrical service across much of the United States, are leading examples of natural monopoly. As a result, one firm is able to supply the total quantity demanded in the market at lower cost than two or more firms-so splitting up the natural monopoly would raise the average cost of production and force customers to pay more. This typically happens when fixed costs are large relative to variable costs. A natural monopoly arises when average costs are declining over the range of production that satisfies market demand. A natural monopoly poses a difficult challenge for competition policy, because the structure of costs and demand makes competition unlikely or costly.

Contrast cost-plus and price cap regulation.Interpret a graph of regulatory choices.Evaluate the appropriate competition policy for a natural monopoly.By the end of this section, you will be able to:

Regulated monopoly examples