It becomes most efficient for production to be concentrated in a single firm. For natural monopolies, the average total cost declines continually as output increases, giving the monopolist an overwhelming cost advantage over potential competitors. Each of these factors contributes to reductions in the long-run average cost of production.Įconomies of Scale: Large firms obtain economies of scale in part because fixed costs are spread over more units of output.Ī natural monopoly arises as a result of economies of scale. Economies of scale are also gained through bulk-buying of materials with long-term contracts, the increased specialization of managers, ability to obtain lower interest rates when borrowing from banks, access to a greater range of financial instruments, and spreading the cost of marketing over a greater range of output. They discourage potential competitors from entering a market, and thus contribute to the monopolistic power of some firms.Įconomies of scale are cost advantages that large firms obtain due to their size.They occur because the cost per unit of output decreases with increasing scale, as fixed costs are spread over more units of output. Natural monopoly: Occurs when a firm is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms.Įconomies of scale and network externalities are two types of barrier to entry.Network externalities: Are evident when the value of a product or service is dependent on the number of other people using it.economies of scale: The characteristics of a production process in which an increase in the scale of the firm causes a decrease in the long run average cost of each unit.This makes competing goods or services with lower levels of adoption unattractive to new customers. Network effects occur when the value of a good or service increases because many other people are using it.Natural monopolies have overwhelming cost advantages over potential competitors. Natural monopolies arise as a result of economies of scale.Economies of scale are cost advantages that large firms gain because of their size.De Beers' market share fell from as high as 90 percent in the 1980s to less than 40 percent in 2012. The sale of diamonds also suffered from rising awareness about blood diamonds. The De Beers model changed at the turn of the 21st century, when diamond producers from Russia, Canada, and Australia started to distribute diamonds outside of the De Beers channel. De Beers also purchased and stockpiled diamonds produced by other manufacturers in order to control prices through supply. In instances when producers refused to join, De Beers flooded the market with diamonds similar to the ones they were producing. It convinced independent producers to join its single channel monopoly. De Beers had a monopoly over the production of diamonds for most of the 20th century, and it used its dominant position to manipulate the international diamond market.
De Beers Consolidated Mines were founded in 1888 in South Africa as an amalgamation of a number of individual diamond mining operations. This is a classic outcome of imperfectly competitive markets.Ī classic example of a monopoly based on resource control is De Beers. In other words, resource control allows the controller to charge economic rent. Single ownership over a resource gives the owner of the resource the power to raise the market price of a good over marginal cost without losing customers to competitors.
market power: The ability of a firm to profitably raise the market price of a good or service over marginal cost.In practice, monopolies rarely arise because of control over natural resources.De Beers had a lot of market power in the world market for diamonds over the course of the 20th century, keeping the price of diamonds high. De Beers is a classic example of a monopoly based on a natural resource.Single ownership over a resource gives the owner the power to raise the market price of a good over marginal cost without losing customers to competitors.
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