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Chapter 15: Problem 12

In China, the government owns many more firms than do governments in the United States. A former Chinese government official argued that a number of government-run industries such as oil refining were natural monopolies. Is it likely that oil refining is a natural monopoly? How would you be able to tell?

Short Answer

Expert verified
Oil refining could potentially be seen as a natural monopoly due to the high barriers to entry typically associated with it. However, without specific cost data, it's unclear whether economies of scale are present to the extent that would definitively qualify it as a natural monopoly.

Step by step solution

01

Understanding Natural Monopoly

A natural monopoly occurs when, due to the unique characteristics of a particular industry, a single firm can serve an entire market at a lower cost than two or more firms would. The defining characteristics of a natural monopoly are high fixed costs, often due to large infrastructure investments that serve as high barriers to entry, and economies of scale that persist over the relevant range of output.
02

Applying the Criteria to Oil Refining

With an understanding of what constitutes a natural monopoly, the next step is to evaluate the oil refining industry on those terms. Significant investments in infrastructure are required for oil refining, presenting potentially high barriers to entry. Therefore, it's possible that given the high start-up costs, a single entity might be able to refine oil more cost-efficiently.
03

Assessing Economies of Scale in Oil Refining

Economies of scale refers to the cost benefits reaped by increasing output. In industries with high fixed costs, it can often be cheaper in terms of average cost per unit to generate more output. For the oil refining industry, this would mean examining whether refining more oil results in lower average costs.
04

Conclusion

To definitively conclude whether oil refining is a natural monopoly, access to specific data on costs of entry and economies of scale in the industry is necessary. However, given the high costs of entry, oil refining does present some characteristics of a natural monopoly.

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