Why is L&P Power considered a natural monopoly?

• A. Because it faces constant marginal costs regardless of output.
• B. Because it is the only firm legally allowed to operate in the market.
• C. Because it can supply the entire market at a lower cost than multiple competing firms due to economies of scale.
• D. Because it sets prices based on consumer demand.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the definition of a natural monopoly. A natural monopoly occurs when a single firm can supply the entire market demand at a lower cost than multiple firms due to significant economies of scale.
2. Step 2: Recognize that economies of scale mean that as the firm increases production, the average cost per unit decreases, making it inefficient for multiple firms to operate simultaneously.
3. Step 3: Analyze why L&P Power fits this definition: it can produce the total market output more cheaply than if several smaller firms each produced part of the output, due to its cost structure and scale advantages.
4. Step 4: Contrast this with other options: constant marginal costs do not necessarily imply a natural monopoly; legal exclusivity is a regulatory barrier, not an economic reason; setting prices based on consumer demand is a pricing strategy, not a cause of natural monopoly.
5. Step 5: Conclude that the key reason L&P Power is considered a natural monopoly is its ability to supply the entire market at a lower cost than multiple competing firms, driven by economies of scale.