Sunday, July 22, 2007

Monopolies and Economies of Scale

A student asked me Saturday about the difference of economies of scale and high fixed costs concerning the justification of monopolies. Monopolies originate in many ways and two of those ways--costs decrease as output increases for the entire market (also known as a natural monopoly) and requiring a lot of investment to get started--seemed completely entangled to him. I sympathize--it's hard to imagine an industry that has economies of scale but low fixed costs. Aren't they really the same thing?

In truth, they are distinct, though subtly so. A natural monopoly can provide for the whole of the economy at decreasing costs. Even if a firm could overtake the fixed costs of entry, the existing firm could undercut the challenger. And even if we assume that the reason the existing firm has economies to scale for the whole market is open to anyone, competition will not last. The demand is simply not large enough to support more than one firm and eventually only one company will remain. True, under rare circumstances it may not be the monopoly that existed beforehand. But a monopoly will naturally appear.

1 comment:

Anonymous said...

I wish I understood you.