chapter  13
Natural Monopoly
Pages 28

The previous chapter dealt with the costs that the incidence of private monopoly may impose upon society owing to the lower levels of output and higher prices than would prevail under a competitive environment. Clearly the outcome of such an approach is that, at the static level at least, monopoly may be undesirable from the viewpoint of economic efficiency. However, there are instances where efficiency dictates that demand is met by a single producer. This is the case of natural monopoly. In such a situation the costs of supply exhibit characteristics such that single-firm production is always more efficient than multi-firm production. In the single-product case such a situation is caused by substantial (and often unexploited) economies of scale induced by a high fixed cost component. In a multiproduct industry it is largely caused by a combination of economies of scale and scope. In such circumstances there is clearly a public policy problem. This is because, although efficiency requires single-firm production, this may occur at the expense of allocative efficiency. The monopolist is in a powerful position to charge prices that more than cover costs of production. The natural monopoly problem therefore is one of ensuring that industry output is produced at minimum cost (private and social) and sold at prices that reflect these costs. The postwar approach in the UK until the 1980s was the exclusive public ownership of such activities. Apparent dissatisfaction with this solution has led to the recent programme of privatisation accompanied by regulation. In this chapter we first consider the conditions which give rise to the natural monopoly problem and the welfare issues raised. We also look at the practical policy issues raised and the ‘solutions’ adopted: public ownership (section 13.4), privatisation (section 13.5) and regulation (section 13.6). A major conclusion is that ownership (whether public or private) by itself is not an adequate solution to the natural monopoly problem. Just as public ownership may be criticised on internal efficiency grounds, the system of privatisation and regulation so far adopted appears vulnerable to the charge of permitting potential allocative as well as internal inefficiencies. Moreover, both approaches imply a high level of outside involvement in decision-making. This in turn raises questions

concerning the adequacy of either approach as a solution to the natural monopoly problem and once again highlights the importance of introducing competitive pressures into the industries concerned. The feasibility of introducing competition is the subject matter of the next chapter.