What does a natural monopoly graph look like?
A natural monopoly graph shows an average total cost curve that is still falling where it crosses demand, with marginal cost below it. It marks three outcomes: the unregulated price where MR = MC, the fair-return price where P = ATC, and the socially optimal price where P = MC, which causes a loss.
The graph has price and cost on the vertical axis and quantity on the horizontal axis. It has the usual monopoly curves: a downward-sloping demand curve and a marginal revenue curve below it, twice as steep when demand is a straight line. What makes it a natural monopoly is the cost side. The average total cost (ATC) curve slopes downward across the whole range of market demand, because large fixed costs, such as water pipes or power lines, are spread over more and more units. Since ATC is falling, marginal cost (MC) sits below ATC across the whole range of demand, and it is often drawn flat.
The way to spot it is where ATC meets demand: in a natural monopoly, ATC is still falling at that crossing. In an ordinary monopoly graph, ATC is U-shaped and MC cuts through its lowest point. The natural monopoly vs monopoly comparison sets out how the cost curves differ, row by row. Falling ATC across the market reflects the economies of scale that make one firm cheaper than two.
Numbers make the three prices concrete. Let demand be P = 100 - Q, so MR = 100 - 2Q. Let MC be a constant $20 and fixed cost be $1,200, so ATC = 20 + 1,200 / Q, which falls at every quantity. Unregulated, the firm sets MR = MC: 100 - 2Q = 20 gives Q = 40, the price on demand is $60, ATC is 20 + 30 = $50, and economic profit is (60 - 50) times 40 = $400. Two firms splitting 60 units would each make 30 at an ATC of 20 + 40 = $60, versus $40 for one firm making all 60, which is why one firm is cheaper.
The socially optimal price is where demand crosses MC: 100 - Q = 20 gives Q = 80 and P = $20. Output is allocatively efficient, but ATC at 80 units is 20 + 15 = $35, so the firm loses ($35 - $20) times 80 = $1,200 and would shut down without a subsidy. The fair-return price is where demand crosses ATC: 100 - Q = 20 + 1,200 / Q gives Q = 60 and P = $40, and ATC there is 20 + 20 = $40, so economic profit is zero. (Demand also crosses ATC at 20 units, but the regulator wants the larger output.) Price is still above MC, so a smaller deadweight loss remains: 0.5 times (80 - 60) times (40 - 20) = $200, compared with 0.5 times (80 - 40) times (60 - 20) = $800 unregulated.
So a complete natural monopoly graph labels three quantities on the horizontal axis (40, 60, and 80 in the example) and three prices on the vertical axis ($60, $40, and $20), with the profit rectangle at the unregulated point and the loss rectangle at the socially optimal point. The socially optimal vs fair-return price comparison explains the regulator's choice, and the monopoly sandbox lets you compare these curves with an ordinary monopoly, where ATC is U-shaped.
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Related questions
- Why does the socially optimal price cause a loss for a natural monopoly?
- Because ATC is falling, marginal cost lies below average total cost. Setting price equal to marginal cost therefore sets price below average total cost, so each unit sells for less than it costs on average and the firm loses money unless the government covers the gap.
- Which regulated price do governments usually use?
- Regulators usually set prices close to the fair-return price, where price equals average total cost, because the firm covers its costs without a subsidy. Utility [rate-of-return regulation](/glossary/rate-of-return-regulation) works this way. The trade-off is that some deadweight loss remains, since price is still above marginal cost.
- Why is the MC curve below the ATC curve on a natural monopoly graph?
- Whenever an average is falling, the marginal value pulling it down must be below it. ATC falls across the whole range of demand in a natural monopoly, so MC stays below ATC the entire way and never crosses it at a minimum the way it does on a U-shaped ATC curve.