Which of the following reasons explains why a natural monopoly might exist?

• A. Government regulation prohibits entry of new firms into the market.
• B. Firms in the market engage in price discrimination.
• C. High fixed costs and economies of scale make it most efficient for a single firm to supply the entire market.
• D. The product is highly differentiated and consumers prefer variety.

Answer: (C)

Verified step by step guidance

1. Understand the concept of a natural monopoly: it occurs when a single firm can supply the entire market at a lower cost than multiple firms due to high fixed costs and significant economies of scale.
2. Recognize that government regulation prohibiting entry is a legal barrier, not the fundamental economic reason for a natural monopoly's existence.
3. Note that price discrimination is a pricing strategy used by firms but does not explain why a natural monopoly forms in the first place.
4. Consider that product differentiation and consumer preference for variety typically lead to competitive markets, not natural monopolies.
5. Conclude that the key reason for a natural monopoly is that high fixed costs and economies of scale make it most efficient for one firm to serve the entire market, minimizing average costs.