Natural monopoly means a form of monopoly, where the demand for various goods or services is satisfied by one or more enterprises. At the same time, large investments are required at the initial stage, and the project needs a long time to pay off. Usually, one company conducts business as it can be the only supplier of a particular product on the market. Natural monopolies emerge in the spheres that contemplate special raw materials, equipment, or other elements for functioning.
Essence of Natural Monopoly
A natural monopoly is a state of a commodity market with specific characteristics, where participants are able to operate properly only in case of the absence of competition. Otherwise, the costs will cease to be minimal, and it will seriously reduce profits. For instance, OPEC can be called the example of a natural monopoly.
A natural monopoly is based on the economic indicators of a certain market. Concurrently, the activity of a unique market participant could be effective in a perspective. Thus, the emergence of natural monopolies is dictated by the market itself, not taking into account the desire of its actors and their decisions.
Let’s consider the most significant characteristics of a natural monopoly:
- high barriers to enter the market, as fixed costs associated with the construction of various structures can’t be always justified;
- a network-based character of the market, meaning the existence of integral networks for providing services;
- a low responsiveness of demand, implicating a less reliance on price, as goods and services may not be replaced. Moreover, these products meet the most important needs of the population or other industries.
Forms of Natural Monopoly
The emergence of natural monopolies is an external reality. And there exists two general types of this phenomenon:
- Environmental monopoly. Its formation is determined by certain natural conditions. A prime example is the mining industry, where the extraction of subsoil resources occurs by particular companies. A firm, whose geologists have discovered a deposit of unique minerals, has bought the rights to a land, where this deposit is located. It can become a monopolist. As a rule, other enterprises are not able to use the deposit: the law protects the owner's rights.
- Technical and economic monopoly. It arises against the background of scaling, for economic or technical reasons. A case in point is the development of rail transport. Or another example. It is almost impossible to create two sewers in the city, gas supply stations or to provide electricity for apartments. These actions can even be called irrational. Thus, economies of scale are particularly incentivized to increase the enterprise size in order to reduce the average cost of producing goods. In reality, a creation of a slightly smaller size, instead of one major monopoly firm, can lead to an increase in production costs and, as a result, in prices.
Notice: natural monopoly exists only if there is a reason to have an enterprise or a service provider in the sector or geographical area.
Regulation methods of Natural Monopoly
As it was mentioned before, the presence of natural monopolies is a reality. But if it is not regulated at the state, regional or local level, the overall situation can worsen. For instance, there exists a possibility of a surge in prices, a shortage of essential goods, their complete absence, and a failure of replacing. Considering the interconnectedness of economic sectors, this may result in a crisis on a national scale.
To regulate the actions of natural monopolies, various instruments are used. These tools are divided into three groups:
- Direct price regulation for products of natural monopolists. The setting of prices and tariffs for the services is based on various reasons, for example, a care for particular consumer categories, service value for consuming industries, etc.
- Indirect price regulation through the establishment of maximum profit values. There exist two main methods: imposing limits on price increases and fixing the rate of return.
- Competitive mechanisms for the rights’ transfer to manufacture products. For instance, the competitive sale of licenses that allows the enterprise to become a natural monopolist.A case in study is the transfer of certain railways to concessions in Argentina, Brazil and some other developing countries in order to increase the functioning efficiency.
Natural Monopoly in real life
Natural monopoly is present almost in every country of our modern world. Thereby, its occurrence can be traced in the fields of telephone service, power supply, transportation, etc. Moreover, natural monopoly takes place in oil and gas extraction and transit, along with postal and electronic communications for general use.
Cases in study concerning natural monopoly are different. In the legislative acts of Western states, the term refers to the public need for service. The UK possesses natural monopoly in the spheres of railway facilities, electricity transmission and distribution, water supply and sewerage.
The French concept anticipates “commercial and industrial public services”. Natural monopolies, there, are present in the following sectors: communication, railway transport, as well as electricity.
A natural monopoly in Germany is a situation, when the company is able to meet the consumers’ demand, offering a service at a low price, providing at the same time a decent level of profitability. It alludes to the spheres of pipeline and railway transportation.