In a traditional monopoly, all or most sales are in a market are undertaken one
ID: 1234131 • Letter: I
Question
In a traditional monopoly, all or most sales are in a market are undertaken one company. In a natural monopoly, the cost-technology of an industry where is is most cost efficient to be run by one company and a good example of this would be public utilities, therefore society in this case would benefit from natural monopolies. Traditional monopolies are illegal because they eliminate competitive pricing because if one firm controls an entire industry they could set there own prices with no competitors.Explanation / Answer
William Baumol (1977) provided the current formal definition of a natural monopoly where “an industry in which multiform production is more costly than production by a monopoly”. He linked the definition to the mathematical concept of subadditivity; specifically of the cost function. Baumol also noted that for a firm producing a single product, scale economies were a sufficient but not a necessary condition to prove subadditivity. Utilities are often natural monopolies. In industries with a standardized product and economies of scale, a natural monopoly often arises. In the case of electricity, all companies provide the same product, the infrastructure required is immense, and the cost of adding one more customer is negligible, up to a point. Adding one more customer may increase the company's revenue and lowers the average cost of providing for the company's customer base. So long as the average cost of serving customers is decreasing, the larger firm more efficiently serves the entire customer base. Of course, this might be circumvented by differentiating the product, making it no longer a pure commodity. For example, firms may gain customers who pay more by selling "green" power, or non-polluting power, or locally-produced power.
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