What is a natural monopoly? Monopolies arising from economies of scale and the case of electricity and water

A natural monopoly refers to a monopoly in which, even though competition is not prevented by law, it is cheaper for one company to supply the entire market demand than for multiple companies to share the supply, resulting in only one company remaining. A representative example is an industry where installing equipment twice would result in waste, such as transmission and distribution grids or water pipes that send electricity to homes.

This is a concept that always comes up when learning about market failure in economics and microeconomics classes, so if you organize the principles and regulations at once, you can use it for assignments and exams.

Why do natural monopolies arise?

The key is economy of scale. Like power plants, transmission networks, and railways, there are huge fixed costs to initially install them, but once they are in place, the additional cost of acquiring one more customer is very small. So, as production increases, fixed costs are divided among more customers and the average cost continues to fall.

In this structure, companies that have equipment first can supply at a low cost, making it difficult for companies that come in late to compete due to the burden of having to install new equipment. This is a naturally occurring barrier to entry.

In economics, this situation is sometimes explained as a case where the total cost of production by one company is less than the sum of the total costs of production by multiple companies.

In other words, the starting point of a natural monopoly is that it arises from the cost structure of the industry, not from corporate misconduct.

How is it different from a regular monopoly?

General monopolies often arise from devices that block competitors, such as patents, resource monopolies, and collusion. On the other hand, a natural monopoly is a case where forcing competition increases the overall cost to society. So, in a natural monopoly, the main task is to prevent monopolies from raising prices too much, rather than eliminating the monopoly.

The phenomenon of increasing value as the number of users increases It is also related to the concept of network effect and platform economy. In industries such as telecommunications networks, where the more people are connected, the more convenient it is, economies of scale on the cost side and network effects on the demand side can both foster monopolies.

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How does the government regulate natural monopolies?

If left alone, monopolies have an incentive to reduce production and raise prices. So the government uses several methods.

• Public enterprise operation: Directly supplied by the government or public institutions. Korea’s Korea Electric Power Corporation is a representative example.
• Rate regulation: Even if supplied by a private company, the government approves or sets a cap on the rate.
• Average cost price setting: If the price is set according to the marginal cost, it will be lower than the average cost and result in a loss, so setting the price at the average cost level is often used.

However, regulated monopolies may have less incentive to reduce costs, so how to maintain efficiency remains a long-standing problem in regulatory policy.

Will natural monopolies disappear as technology changes?

Natural monopolies do not last forever. In the days of landline phones, it was natural for one company to monopolize the phone network, but as mobile communications and Internet technology developed, the market changed into a market where multiple companies compete. In the electric power industry, discussions have continued to divide the structure so that multiple business operators participate in the power generation sector and only the transmission and distribution sector that uses the network is left as a monopoly.

So, in your assignment, rather than just writing about the principle of natural monopoly, you can naturally connect your views on the free market by also writing about the fact that technological innovation changes the cost structure, which can weaken the basis for monopoly.

How should I use the natural monopoly task?

The report has a clear flow if you write it in the following order: Definition of natural monopoly → Causes of occurrence (economies of scale, infrastructure, network) → Domestic cases → Regulation method → My opinion on the market and innovation. It's much easier to explain if you put in a figure showing the average cost curve going down to the right, and get figures like rates and facility size from the agency's official data with the base year. Campus-like natural monopoly summary material can be a reference for those who want to organize principles and cases in economic theory or industrial organization theory assignments.