costly. A natural monopoly arises when average costs are declining over the range of production that satisfies

market demand. This typically happens when fixed costs are large relative to variable costs. As a result, one

firm is able to supply the total quantity demanded in the market at lower cost than two or more firms—so

splitting up the natural monopoly would raise the average cost of production and force customers to pay more.

Public utilities, the companies that have traditionally provided water and electrical service across much of the

United States, are leading examples of natural monopoly. It would make little sense to argue that a local water

company should be divided into several competing companies, each with its own separate set of pipes and

water supplies. Installing four or five identical sets of pipes under a city, one for each water company, so that

each household could choose its own water provider, would be terribly costly. The same argument applies to
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