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Increasing Returns and Efficiency

The key point is that a natural monopoly is characterized by increasing returns to scale at all levels of output — thus the long run cost per unit LRAC will drift lower as production expands. This can be illustrated in the diagram below. There may be room only for one supplier to reach the minimum efficient scale and achieve productive efficiency. Because there is no single definition of a natural monopoly, none of the examples below are purely national monopolies — their cost structure does take them close to a common-sense interpretation:.

The profit-maximizing price is P1 at an output of Q1. Price is well above the marginal cost of supply and high supernormal profits are made — but output is high too and there is still a sizeable amount of consumer surplus because of the internal economies of scale that have brought down the unit cost for all consumers. We are ignoring the possibility of price discrimination here.


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Network Rail is a not-for-profit business formerly Railtrack plc — nationalized in For many utilities, the government introduced industry regulators to oversee these businesses when they were privatized in the s and early s. For many years utility businesses were subject to price capping— most of these have now finished although some remain.


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    Returns to scale - Wikipedia

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    Economics Reference library. In this study note we explore the key concept of natural monopoly. What is a natural monopoly?

    There are several interpretations of what a natural monopoly us It occurs when one large business can supply the entire market at a lower price than two or more smaller ones A natural monopoly is a situation in which there cannot be more than one efficient provider of a good. In this situation, competition might actually increase costs and prices It is an industry where the minimum efficient scale is a large share of market demand such there is room for only one firm to fully exploit all of the available internal economies of scale An industry where the long run average cost curve falls continuously as output expands Private utilities are natural monopolies in local markets The key point is that a natural monopoly is characterized by increasing returns to scale at all levels of output — thus the long run cost per unit LRAC will drift lower as production expands.

    Since it also operates the electricity transmission network in Scotland. Owns and operates the gas transmission network from terminals to distributors London Underground , Tyne and Wear Metro, Manchester Tram Network Key point: A natural monopoly does not mean that there is only one business operating in the market There may be many smaller businesses operating profitably in smaller 'niche' segments of a market however that is defined With a natural monopoly the economies of scale available to the largest firms mean that there is a tendency for one business to cominate the market in the long run Possible conflicts between efficiency and economic welfare It is often said that a natural monopoly raises difficult questions for competition policy because On the one hand — it is more productively efficient for there to be one dominant provider of a national infrastructure e.

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    In December , Microsoft agreed to allow consumers to choose their web browser on setup. Removing the pre-installation of the software will mean that more firms will be able to enter the market. Introducing competition into the industry -this has been a favoured policy.

    This means separating out infrastructure from the final service to the consumer e. BAA: In the UK Competition Commission required British Airports Authority to sell off three of its seven airports, starting with Gatwick and then Stansted National Rail runs the network — but train-operating companies have to bid for the franchise to run passenger services — and the industry regulator can take their franchise away if the quality of service isn't good enough. The government took the East Coast line into public ownership in July following the financial problems facing National Express.

    Subscribe to email updates from tutor2u Economics Join s of fellow Economics teachers and students all getting the tutor2u Economics team's latest resources and support delivered fresh in their inbox every morning. You're now subscribed to receive email updates! Print page. Related Collections. Monopoly Power Collections. Economies and Diseconomies of Scale Collections. Economic Efficiency Collections. You might also like.

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    Email this article Login required. Email the author Login required. About The Author Hal R. Abstract The classic prescription for economically efficient pricingset price at marginal costis not relevant for technologies that exhibit the kinds of increasing returns to scale, large fixed costs, or economies of scope found in the telecommunications and information industries.

    The appropriate guiding principle in these contexts should be that the marginal willingness to pay should be equal to marginal cost. This condition for efficiency can be approximated using differential pricing, and will in fact, be a natural outcome of profit-seeking behavior.

    Keywords differential pricing; pricing efficiency; efficiency of markets; economies of scope; increasing returns to scale; economic efficiency; Pareto efficient; nonlinear prices; price differentiation; article.