Natural monopoly

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Natural monopoly

• Implications for competition and essential
  facilities access

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Preliminary where have we been
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Preliminary where are we going
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Overview

• What is a natural monopoly?
• Natural monopolies and market conduct
• Natural monopolies and vertical production chains
• Essential facility access
• Other cases of access

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What is a natural monopoly?

• The term natural monopoly refers to a cost
  minimising technology such that, at all relevant
  levels of output, it is more efficient to have
  that output supplied by one firm than by more
  than one firm

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The classic natural monopoly
High fixed costs, low marginal costs, average
cost falling over relevant range of output. If
uniform pricing and PMC, firm makes a loss. To
get PMC for marginal price, need non-linear
pricing If leave to monopoly, will get monopoly
pricing Examples most utility industries
(fixed-line telephone systems, gas, water,
electricity. Towage in most Australian ports
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Natural monopolies and markets

• The natural monopoly status of an industry
  changes
• as technology changes
• as demand changes
• Will a natural monopoly technology lead to a
  monopoly producer?
• The role of contestability

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Standard contestability
Notes If no sunk costs and no exit or entry
barriers. If entrant can win all sales by
slightly undercutting incumbents price. If
customers can move to entrant before the
incumbent can alter price. If entrant can
costlessly leave when incumbent lowers
price. Then contestability will push price to
average cost.
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Contestability and competition for the market

• Suppose buyers can organise so that they tender
  out for a monopoly supplier.
• The firm that offers the lowest price will win
  the contract.
• Then winning contract will set Price Average
  Cost
• We get the same outcome as a perfectly
  contestable market
• This is the lowest uniform price that any firm
  can set and not make a loss
• Example Port of Bunbury

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Lessons (part 1)

• Natural monopolies MAY be fixed by the market
• But often regulation will be needed to allow
  efficient production and pricing
• And uniform pricing can never maximise gains from
  trade need non-linear prices.

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Natural monopoly in vertical production chains

• Suppose that a natural monopoly industry provides
  an input for further production
• Essential Facilities Need to pass two
  essentiality tests
• Are they essential inputs?
• Are there alternative outputs?
• The role of essential facilities access
• The Australian approach under Part IIIA of the
  Trade Practices Act

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Negotiated access

• Suppose an upstream natural monopoly is required
  to negotiate to supply its product to a
  downstream firm
• What is the expected outcome if any prices can be
  negotiated?
• What is the expected outcome if there are
  limitations on the prices being negotiated?
• How will these change if the upstream natural
  monopoly also competes in the downstream market?

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Lessons (part 2)

• Negotiated pricing in a vertical production chain
  with an upstream monopoly sets the likely outcome
  as integrated monopoly pricing (or something
  close to it and probably worse than integrated
  monopoly)

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Access to other facilities
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Lessons (part 3)

• Before considering access to an essential
  facility need to consider
• Is it really essential?
• Is there a better alternative?