Which of the following statements concerning a natural monopoly is true?

• A. Government regulation is never necessary for natural monopolies.
• B. Natural monopolies are characterized by decreasing average costs as output decreases.
• C. A natural monopoly always results in perfectly competitive market outcomes.
• D. A natural monopoly occurs when a single firm can supply the entire market at a lower cost than multiple competing firms.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the definition of a natural monopoly. A natural monopoly exists when a single firm can supply the entire market demand at a lower cost than multiple firms could, due to economies of scale over the relevant range of output.
2. Step 2: Analyze the cost structure of a natural monopoly. Typically, a natural monopoly has decreasing average costs as output increases, meaning the firm experiences economies of scale, not decreasing average costs as output decreases.
3. Step 3: Evaluate the role of government regulation. Because natural monopolies can lead to inefficient market outcomes (such as higher prices and restricted output), government regulation is often necessary to protect consumers and ensure fair pricing.
4. Step 4: Consider market outcomes. A natural monopoly does not result in perfectly competitive outcomes because there is only one supplier, and the firm has market power to set prices above marginal cost.
5. Step 5: Conclude which statement is true. The correct characterization is that a natural monopoly occurs when a single firm can supply the entire market at a lower cost than multiple competing firms, reflecting economies of scale and cost advantages.