Natural Monopoly and Its Regulation

A firm that is the only seller of a product or service having no close substitutes is said to enjoy a monopoly 1 Monopoly is an important concept to this Article but even more important is the related but somewhat less familiar concept of "natural monopoly."The term does not refer to the actual number of sellers in a market but to the relationship between demand and the technology of supply.If the entire demand within a relevant market can be satisfied at lowest cost by one firm rather than by two or more, the market is a natural monopoly, whatever the actual number of firms in it.If such a market contains more than one firm, either the firms will quickly shake down to one through mergers or failures, or production will continue to consume more resources than necessary.In the first case competition is short-lived and in the second it produces inefficient results.Competition is thus not a viable regulatory mechanism under conditions of natural monopoly.Hence, it is said, direct controls are necessary to ensure satisfactory performance: controls over profits, specific rates, quality of service, extensions and abandonments of service and plant, even permission whether to enter the business at all.This set of controls has been applied mainly to gas, water, and electric power companies, where it is known as "public utility regulation," and to providers of public transportation and telecommunications, where it is known as "common carrier regulation."(I shall use "regulation" or "public utility regulation" to refer to both.)The question that this Article addresses is whether natural monopoly provides an adequate justification for the imposition of these regulatory controls 2