Economies of Scale, Natural Monopoly and Imperfect Competition in an Experimental Market

Abstract

This paper reports on the behavior of markets in which all agents have identical costs with economies of scale over the entire range of demand. Each firm, by choosing a larger scale of plant and a larger volume, can experience lower average cost. Thus the markets are characterized by the fundamental technological property that has motivated decades of theorizing about natural monopoly and imperfect competition. The primary question posed by the research is whether or not a natural monopoly emerges and sets prices at monopoly levels or whether the data are more closely approximated by some alternative model of imperfect competition such as monopolistic competition, Cournot oligopoly or contestable market theory. The results are that monopoly emerges and charges prices closely approximated by contestable market theory. No support is found for Cournot forms of oligopoly or for other types of monopolistic competition.