Tests for Natural Monopoly

  • Mark A. Jamison
Part of the Studies in Industrial Organization book series (SIOR, volume 22)


Even with recent trends towards liberalization of utility markets, many countries are choosing to treat some parts of their utility industries as a natural monopoly and keeping these parts closed to competition. In energy, most of the market reform models discussed in Chapter 2 open power generation to competition (Hunt and Shuttleworth 1996 pp. 12–13), but do not necessarily open all markets. For example, leading countries such as Argentina, Chile, Norway, and the UK have chosen to let monopolies provide transmission and distribution. The common thinking is that these functions are natural monopolies. (Estache and Rodriguez-Pardina 1997, p.81; Gray 1996, pp. 15, 35, 53; Lalor and Garcia 1996, pp. 43–44)


Market Structure Market Transaction Industry Structure Joint Production Electricity Distribution 
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  1. 1.
    More formally, a firm’s cost function has economies of scale if λC(q) < Cq), where q is the vector of outputs.Google Scholar
  2. 2.
    Figure 1 is adapted from Porter (1985, p. 354).Google Scholar
  3. 3.
    More formally, if the output levels q 1,…, q k sum to q, then costs are strictly subadditive if C(q) < C(q 1) +…. + C(q k) for every k ≥ 2, where C(·) is the cost function.Google Scholar
  4. 4.
    See Appendix 1.1 for definitions of cost concepts.Google Scholar
  5. 5.
    Sharkey (1982b, p. 64) explains that if input markets are not competitive, then natural monopoly should be defined as superadditivity of the production function.Google Scholar
  6. 6.
    Falling average costs and falling marginal costs over all q result in strict subadditive costs only if producing no output results in non-negative costs.Google Scholar
  7. 7.
    More formally, a cost function C(q 1, q 2) has economies of scope if C(q 1, q 2) < C(q 1, 0) + C(0, q 2).Google Scholar
  8. 8.
    More formally, SMN, LN, and ML=Ø.Google Scholar
  9. 9.
    Figure 2 is adapted from Porter (1985, p. 354).Google Scholar
  10. 10.
    Other concepts of efficiency would include welfare maximization and dynamic efficiency.Google Scholar
  11. 11.
    Many would dispute this assumption in actual electricity markets, but it is useful for illustrative purposes.Google Scholar
  12. 12.
    This is a hypothetical example. In practice, an efficient market structure could include various combinations of these products.Google Scholar
  13. 13.
    Regulatory costs will show up as govemment salaries and supply costs, and salaries, fees, and supply costs paid by utilities and other stakeholders that participate in the regulatory process. The only regulatory cost likely to be missed in market transactions is the time and effort consumers exert to participate in regulatory proceedings. Government antitrust costs will also generally show up as market transactions. Examples include government and defendant attorney fees, court costs, wages and salaries, and supplies.Google Scholar
  14. 14.
    Note that q eg and q st are both produced on a stand-alone basis in this market structure.Google Scholar
  15. 15.
    This assumes that the monopoly’s products are part of, and/or result in, a set of final goods for the economy that maximize social welfare. It is probably impractical to assume otherwise or to test the assumption, except in clear cases where the monopoly products are clearly socially damaging, such as products that are severe pollutants.Google Scholar

Copyright information

© Springer Science+Business Media New York 2000

Authors and Affiliations

  • Mark A. Jamison
    • 1
  1. 1.Public Utility Research CenterUniversity of FloridaGainesvilleUSA

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