Business Degree Certification Practice Test

What characterizes natural monopolies?

1. Economies of Scale (Increasing returns to scale)

2. Constant Returns to Scale

3. Diseconomies of Scale (Decreasing returns to scale)

4. Non-existent returns to Scale

The correct answer is: Economies of Scale (Increasing returns to scale)

Natural monopolies are characterized primarily by the presence of economies of scale, which refers to the cost advantages that a firm experiences as it increases its output level. In a natural monopoly, a single firm can produce the entire output of the market at a lower cost than multiple competing firms due to these economies of scale. This typically occurs in industries where the fixed costs of infrastructure or technology are very high relative to the variable costs. For example, utilities such as water, electricity, and gas often exhibit natural monopoly characteristics, as the infrastructure needed to deliver these services is costly and can lead to significant savings when managed by a single provider. If multiple firms were to enter the market, it would lead to unnecessary duplication of infrastructure, resulting in higher overall costs for consumers. The other choices relate to varying types of efficiency that do not align with the nature of natural monopolies. Constant returns to scale suggests that increasing output does not change the cost per unit, while diseconomies of scale imply that costs increase as output increases. Non-existent returns to scale is not a typical concept applied in this context either. Hence, economies of scale effectively capture the essence of why natural monopolies can exist in certain industries.