It is claimed that a natural monopoly has increasing returns to scale.
 Explain what increasing returns to scale are, explain what increasing
returns to scale does to the firm's average total cost curve, and
explain why this leads to a natural monopoly.

Hi k9queen!
The definition of increasing returns to scale can be found at the
following link

Increasing returns to scale
http://www.amosweb.com/cgi-bin/gls.pl?fcd=dsp&key=increasing+returns+to+scale

Causes for increasing returns to scale to exist are given in the
following link, along with an explanation of the decreasing average
total cost curve

Increasing returns to scale
http://william-king.www.drexel.edu/top/prin/txt/Cost/cost19.html

In sum, firms with increasing returns to scale are usually firms which
have large fixed costs and very small variable costs. Utilities are an
example. The water service has a large fixed cost (setting up the
extraction and purification plants, etc). However, once all these
costs have been paid, serving an extra house costs practically
nothing. Thus the average total cost is decreasing with quantity.

Since the average cost is decreasing in quantity, we get the basic
reason why this leads to a natural monopoly: a single large firm can
produce units of the good at a lower cost than several small firms.
For example, suppose that the technology is such that the average cost
of 10 units is $30 and the average cost of 1 unit is $100 (this is
consistent with decreasing average total costs). So if one firm were
to produce ten units, it would have a cost of $300 (30*10); while if
we had ten firms producing one unit each, the total cost would be 1000
(100*10). Therefore, it's more efficient to have one large company
rather than several small ones. If many investors were trying to start
up a business in an industry which exhibits increasing returns, they
would be better off by "joining" to set up a large company instead of
each of them starting up their own company.


Google searchj strategy
"natural monopoly" "increasing returns"
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Clarification of Answer by elmarto-ga on 14 Oct 2003 06:29 PDT

I accidentally pressed the "Post Answer" button :-) As always, if you
have any doubt, please don't hesitate to request a clarification; I
will do my best to explain further.

Best wishes!
elmarto