FIGURE 10 REGULATING A NATURAL MONOPOLY
A natural monopoly exists when economies of scale are so large that the minimum efficient scale of operation is roughly equal to market demand. In this case, efficient production can only be accomplished if the industry lies in the hands of one firm—a monopolist. Yet, if the monopolist is a purely private firm, it will produce only output QM, selling it for price PM (point a). This is the principal rationale for regulating natural monopolies to produce output QR for a price of PR (point b).