Natural Monopoly Natural monopoly occurs when average cost declines over the relevant range of In mand. Note that this definition is in terms of both cost and demand conditions. the case of natural monopoly a single firm can produce the output at lower cost than competition. any other market arrangement, including While the cost-and-demand conditions establish the existence of a natural mo- nopoly the price elasticity of demand determines whether or not the natur- al monopoly has important implications for public policy. The price elasticity o demand measures how responsive price changes. Specifically, the 2Indeed, changes in property values provide a basis for empirically estimating the social costs of externalities. For example, with respect to air pollution, see V. Kerry Smith and Ju-Chin Huang, "Can Markets value Air Quality? A eta-Analysis of Hedonic Property value Models Journal of Political Economy 103() 1995, price elasticity of demand is defined as the percentage change in the quantity de- manded that results from a 1 percent change in price.24 If the absolute value of the price elasticity of demand is less than one (a 1 percent change in price leads to less than a 1 percent reduction in the quantity demanded), then we say that demand is inelas- tic and an increase in price will increase total revenue. A good is unlikely to have in- elastic demand if there are other products that, while not exactly the same, are close substitutes. In such circumstances, the availability of substitutes greatly limits the eco- nomic inefficiency associated with natural monopoly For example, although local cable television markets have the cost-and-demand mo- nopolies, many substitute products, including conventional over-the-air television and DVD players, may prevent cable television companies from realizing large monopoly rents in their local markets. We should also keep in mind that, although we stated the basic definition natural monopoly in static markets in the real world are dynamic. Techn logical change may lead to different cost characteristics, or high prices may brin even superior substitutes. The result may be the elimination monopoly or the supplanting of one natural monopoly technology by anothe For example, especially in developing countries, cellular phones may be direct s stitutes for line-connected phones, providing competition for traditional teleph systems.