Question

Monopolies are illegal in the United States. However, if you live in a city and want to brush your teeth or flush your toilet, you pay the City for water and you have no other options for water providers. Why do we allow this natural monopoly to occur?

Answer 1

This is because a natural monopoly faces a downward sloping average cost function. Note that when average cost declines with greater output, the firm is able to achieve economies of scale. These are advantages in terms of volume discounts and cheaper bulk production. Natural monopolies are allowed in the economy to operate because only they can supply to a greater number of consumers and that too at a continuously declining per unit cost. Other forms of monopoly will start charging a higher price and produce a lower quantity because they face diseconomies of scale as well.