Natural Monopoly and the Question of the Factors of Production

Many economists wrongly believe that a natural monopoly would emerge through price-cutting war in a free market. The cut-throat competition is a process by which a big firm can definitely (according to the theory) drive out the other competitors through price-cutting wars. They argue that this is possible simply because big firms experience lower costs of production than smaller firms due to large-scale production. When all the remaining competitors are out of the game, no one can challenge the monopoly anymore. Apart from Rothbard’s comments, there are some additional serious problems with the theory of natural monopoly.

What happens exactly when a natural monopoly chooses to decrease its supply of goods ? We would have to consider the response of prices of factors of production when a large firm reduces its supply of consumer goods in order to increase prices. If this happens, its own demand for factors of production, necessary for the production of consumer goods, will decrease. Eventually, the prices of factors of production would decline, providing an opportunity for competing firms which can now reduce their production costs. They are thus able to lower their prices and challenge the monopoly (in a cut-throat competition).

Even imagining an unrealistic scenario where the monopoly substitutes for the competitors to the purchase, on a regular basis for preventing the prices from falling, of all the factors of production in excess, the accumulation of those ‘idle’ productive resources is a great loss because such amount exceeds what he needs to replace his existing capital goods. It would be far more advantageous to increase its production to capture a larger market share, which will tend to diminish the prices anyway, especially when in fact an increase in production will reduce the average cost of production, making a big-scale production more profitable.

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