Understanding Natural

Monopolies and the

Monopolist's Avoidance of
the Inelastic Demand
Zone

Group - 11
 Natural Monopoly
• A natural monopoly is a type of monopoly that arises due to unique
circumstances where high start-up costs and significant economies of scale
lead to only one firm being able to efficiently provide the service in a certain
territory.

• A company with a natural monopoly might be the only provider or product

or service in an industry or geographic location.

• Natural monopolies are allowed when a single company can supply a

product or service at a lower cost than any potential competitor but are often
heavily regulated to protect consumers.

Examples of Natural Monopoly

• Internet Providers
• Utility providers such as water, sewer services, electricity transmission and energy
distributors, natural gas transmission
• Telephone Companies, landline services
• Railroads
How is Natural Monopoly Different From a Regular Monopoly

A natural monopoly exists naturally. Market forces allow one

player in the market to become the only player in a certain
industry without stifling the competition. Regular monopolies, on
the other hand, are created when a company controls the market
by eliminating the competition. This happens when a key player
buys up the supply chain and buys its rivals. Monopolies may
lead to the removal of substitute products and services, higher
prices, and low-quality products.
 CHARACTERISTICS OF A NATURAL
MONOPOLY
• They occur naturally in the free market as competitors are willingly or
unwillingly unable to compete with them. Economic forces naturally prevent
other companies from entering the market.

• Usually, this monopoly has the characteristic of a long-run average that is steeply
declining.

• They have curves of marginal costs that decline steeply too.

• It is rational for one firm to supply the entire market. Competition is undesirable.

• As a result, the market has space only for one company to come forward to exert
its monopoly through its completely exploited scale of economies and product
supply in the market.

• Economies of scale make the firms have a high fixed cost. They also have higher
maintenance charges along with a prime initial fixed cost. As this cost is huge,
these firms have to cater to the entire market.
 KEY FEATURES OF A NATURAL
MONOPOLY
 High Initial Investment Costs: Natural monopolies typically involve industries that require substantial upfront expenses,
such as infrastructure and capital investments. These initial costs represent a substantial portion of the overall production
expenses.
 Illustration: Consider a municipal water supply system. The construction and maintenance of a city's water infrastructure,
including pipelines, treatment facilities, and reservoirs, entail considerable capital investment and significant fixed costs.

 Formidable Entry Barriers: Natural monopolies are characterized by significant obstacles that discourage or prevent
other businesses from entering the market and competing effectively. These barriers can encompass legal and regulatory
hurdles, economies of scale, and unrecoverable costs.
 Illustration: The development of a nationwide high-speed rail network is a colossal infrastructure project with considerable
initial costs and regulatory complexities. These barriers make it extremely impractical for multiple firms to independently
construct and operate their own networks.

 Limited or Absent Competition: In natural monopolies, competition is generally minimal or nonexistent. Even if
prospective competitors attempt to enter the market, they frequently find it economically unfeasible to do so, given the
dominance and cost advantages of the existing firm.
 Illustration: Local cable television providers frequently operate as natural monopolies. While satellite or streaming services
may be available, they do not directly compete within the same physical infrastructure and local markets.
Economies of Scale
• Economies of scale are the cost benefits that a company or organization can obtain by
expanding its production, which lowers the average cost per unit of output. In simpler
terms, as a company produces more goods or services, it can produce each unit more
efficiently and at a lower cost.

Economies of scale are caused by:

• Specialization: More work can be done with specialized workers and equipment due to
higher production quantities. As a result of continuous operation of machinery and
increased worker skill and efficiency, downtime and maintenance expenses are
decreased.
• Bulk purchasing: Purchasing inputs in bigger numbers, such as raw materials or
components, frequently yields discounts or lower unit costs.
• Technology advancements- Investments in cutting-edge technology can result in
improved productivity, increased automation, and lower manufacturing costs per unit.
• Distribution Efficiencies: Due to shipping and logistics savings, when output rises, the
cost of distribution and transportation per unit can go down.
Long-Run vs. Short-Run: Economies of scale are typically more achievable in the long run because firms have more
flexibility to adjust various aspects of their operations, such as expanding facilities, adopting new technologies, and
optimizing processes.
Price per unit

Output Quantity
What is Demand?
Demand—The desire for an item and the ability to pay for it

Demand refers to the quantity of a good or service that consumers are willing and able to
purchase at various prices during a specific period of time, all other factors being equal. It
represents the relationship between the price of a product and the quantity of that
product that consumers are willing to buy.
 Law of Demand
1. As PRICE increases, DEMAND decreases

2. As PRICE decreases, DEMAND increases

 Demand Curve

• A graph that illustrates the demand for a

product.
• It shows how much consumer desire for
a product changes as the price changes
Depends on:
• income
• tastes
• prices of competitive products
• prices of complementary products
Elasticity of Demand
The degree to which changes in price cause changes in demand
It quantifies the degree to which consumers adjust their buying behavior when the
price of a product changes.
Elasticity of demand is expressed as a numerical value, and it provides insights into
consumer behavior and market dynamics.
Computing the
Elasticity of Demand

Elasticity of demand measures the percentage change

in quantity demanded divided by percentage change Elasticity values
in price
• >1 it is elastic
• Percentage change in price will result in larger
percentage change in the quantity demanded
Percentage change in
quantity demanded • =1 it is unit-elastic
= • <1 it is inelastic
Percentage change in
price • Demand is usually more elastic at higher prices
and less elastic with lower prices
Elasticity Demand Curves
(b) Perfectly inelastic (c) Unit elastic
(a) Perfectly elastic

ED = ∞

Consumers demand all Consumers demand Q Total revenue is the same for each
quantity offered for sale at p, regardless of price p-q combination
but demand nothing at a price
above p
 Determinants of Demand Elasticity

• Availability of substitutes
The greater the availability of substitutes for a good, the greater the good’s elasticity of demand
• Share of consumer’s budget spent on the good
Increase in prices reduced the demand because people are not both willing and able to purchase
@ higher prices
• A matter of time
The longer the adjustment period, the greater the consumer’s ability to substitute
• Some elasticity estimates
The elasticity of demand is greater in the long run because consumers have more time to adjust
Elastic and Inelastic demand response to price change
Elastic Demand: Elastic demand refers to a situation where a small change in the price of a good or service leads to a relatively
larger change in the quantity demanded.
In elastic demand, consumers are highly responsive to price changes, meaning that if the price increases, the quantity demanded
significantly decreases, and if the price decreases, the quantity demanded significantly increases.
Inelastic Demand:
Inelastic demand, on the other hand, refers to a situation where a change in the price of a good or service leads to a relatively smaller
change in the quantity demanded.
In this case, consumers are not very responsive to price changes.
Here are some real-world examples to illustrate these concepts:
• Elastic Demand: Consider a luxury car brand. If the price of these cars increases, many consumers may choose not to buy them,
and the quantity demanded would decrease significantly. If the price decreases, more people may decide to buy, and the quantity
demanded increases considerably.
• Inelastic Demand: Think about essential goods like insulin for diabetic patients. Even if the price of insulin increases, most patients
will continue to purchase it because it is a life-saving medication. The quantity demanded changes only slightly in response to price
fluctuations.
Monopolist’s Pricing
Short-Run

A monopolist, as contrasted to a perfect competitor, is not a

price taker but can set the price at which it sells the product. The
monopolist sets the price to maximize profits or minimize losses
in the short run. The monopolist is the sole seller of a product
for which there are no close substitutes, the monopolist faces a
negatively sloped market demand curve for the product. That
means monopolists can sell more units of the products only by
lowering their prices. Because of this, the marginal revenue is
smaller than the product price and the marginal revenue curve is Short-Run Price and Output Determination under Monopoly
below the demand curve the monopolist faces
Long-Run Price

In the long run, all inputs and costs of production are

variable, and the monopolist can construct the optimal
scale of the plant to produce the best level of output. As in
the case of perfect competition, the best level of output of
the monopolist is given at the point at which MR=LMC
and the optimum scale of the plant is the one with the
SATC curve tangent to the LAC curve at the best level of
output. As contrasted with perfect competition, however,
entrance into the market is blocked under monopoly, and
so the monopolist can earn economic profits in the Long
run. Because of blocked entry, the monopolist is also not
likely to produce at the lowest point on its LAC curve. Long-Run Price and Output Determination Under Monopoly
Comparison of Monopoly and Perfect Competition

Perfect competition is more efficient than monopoly only if the

lowest point on the LAC curve occurs at an output level that is very
small in relation to the market demand, so as to allow many firms to
operate and, if the product is homogenous, so that perfect
competition is possible. Often this is not the case. A very large scale
of operation is often required to produce most products efficiently,
and this permits only a few firms to operate. For example, economies
of scale operate over a large range of outputs that are steel,
aluminum, automobiles, aircraft, etc., that can meet the entire market
demand for the product or service. Perfect competition under such
conditions would either be impossible or lead to prohibitively high
production costs. The Social Cost of Monopoly
Why Monopolists Avoid Inelastic
Zone
• Profit Maximization Objective:
• Monopolists aim to maximize their profits, making pricing strategy
critical.

• Elastic vs. Inelastic Zone:

• Elastic Zone: Consumers are highly responsive to price changes.
• Small price reductions result in significant quantity increases.
• Total revenue rises with lower prices in this zone.
• Inelastic Zone: Consumers are less responsive to price changes.
• Price increases have minor impacts on quantity demanded.
• Total revenue decreases or remains stable with price changes.
• Monopolist's Dilemma:
Inelastic Zone Challenge:

Raising Prices: Leads to small quantity reductions but higher per-unit prices, decreasing total revenue.

Lowering Prices: Causes minor quantity increases but significant per-unit revenue reductions, again

decreasing total revenue.

• Lower Profits or Losses:

Operating in the inelastic zone typically results in:

Lower profits or even losses for monopolists.

Inability to exploit price changes for profit as effectively as in the elastic zone.

• Conclusion:

By avoiding the inelastic zone and pricing products or services where demand is elastic, monopolists can

make decisions that maximize total revenue and, in turn, their profits, aligning with their primary objective.