Natural Monopoly

Economies of scale can combine with the size of the market to limit competition. (We introduced this theme in

Production, Cost and Industry Structure). Figure 9.2 presents a long-run average cost curve for the airplane
manufacturing industry. It shows economies of scale up to an output of 8,000 planes per year and a price of P0,
then constant returns to scale from 8,000 to 20,000 planes per year, and diseconomies of scale at a quantity of

production greater than 20,000 planes per year.

Now consider the market demand curve in the diagram, which intersects the long-run average cost (LRAC)
curve at an output level of 5,000 planes per year and at a price P1, which is higher than P0. In this situation, the
market has room for only one producer. If a second firm attempts to enter the market at a smaller size, say by

producing a quantity of 4,000 planes, then its average costs will be higher than those of the existing firm, and it
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