Free Entry and the Sustainability of Natural Monopoly

Abstract

Contrary to conventional wisdom, a regulated natural monopoly may be vulnerable to entry by uninnovative competitors even if it is producing and pricing efficiently and earning zero economic profits. The causes and consequences of this unsustainability are theoretically examined in an idealized regulatory environment. In particular, strong demand substitution effects and product-specific scale economies work against sustainability. If natural monopoly is unsustainable, no regulated market structure which provides the entire product set can be sustainable.