Final answer:
A natural monopoly is a type of monopoly where one firm can efficiently supply the entire market demand at a lower cost than multiple firms. It occurs due to economies of scale and declining average costs. Breaking up natural monopolies can lead to higher costs for customers.
Step-by-step explanation:
A natural monopoly is a type of monopoly that occurs when one firm can supply the total quantity demanded in a market at a lower cost than two or more firms. This typically happens when the average costs of production are declining over the range of production that meets market demand. Natural monopolies often arise in industries with large fixed costs relative to variable costs, resulting in economies of scale.
For example, a water company that has already laid the main water pipes in a neighborhood can provide water service to an additional home at a low marginal cost. Splitting up the natural monopoly in such a case would raise the average cost of production, making it expensive for customers.
In summary, a natural monopoly is a situation in which one firm can efficiently supply the entire market demand at a lower cost than multiple firms, due to economies of scale and declining average costs. It is a challenging issue for competition policy, as breaking up natural monopolies can lead to higher costs for customers.