Regulation of Natural Monopolies
The clearest case for public intervention arises with a natural
monopoly —an industry in which economies of scale are so dominant
that there is room for at most one firm to operate at the minimum efficient
scale. (In other words, the firm’s LRAC curve is declining over the entire
range of the market demand curve.) Natural monopolies are found mainly
in public utilities, such as electricity transmission and natural gas
distribution. These industries require the establishment of large and
expensive distribution networks (transmission lines and pipelines), and
the size of the market is such that only a single firm can achieve its
minimum efficient scale while still covering these fixed costs. Local
telephone service and cable TV were also natural monopolies for many
years. Recent technological change, however, has now allowed other
firms to compete effectively in these markets.
One response to natural monopoly is for government to assume
ownership of the single firm. In Canada, such government-owned firms
are called Crown corporations. In these cases, the government appoints
managers and directors who are supposed to set prices in the public
interest rather than to maximize profits for the firm. Another response to
the problem of natural monopoly is to allow private ownership but to
regulate the monopolist’s behaviour. In Canada, both government
ownership (e.g., Canada Post and most of the provincial hydro
authorities) and regulation (e.g., cable television and local Internet
service providers) are used actively. In the United States, with a few