[MUSIC] Let's think through an example of a firm and an environment of a natural monopoly. For example, a transportation system. A transportation company will have large fixed costs for putting the system in place. Buying the busses, setting the routes, having the infrastructure in place. So they're large fixed costs, but the extra cost of having the extra passenger ride on the transportation system is small and probably constant. So again, our graph, a small constant marginal cost, but the average total cost, which includes the fixed cost of setting up the system, starts up very high, but then drops very quickly as we have more people ride the system. If the natural monopoly is left to its own devices and can set any price it wants, we know what the outcome will be. The firm will maximize profits and we know the rule for profit maximization is to produce where marginal revenue equals marginal cost. The firm will be facing a downward sloping demand curve because it's the only firm providing transportation in this economy. And therefore, the marginal revenue curve will lie below it. If the firm is profit maximizing, it will choose the point where marginal revenue equals marginal cost. Which is this output, here. So this is the monopolist output, and we can go up to the demand curve to find the monopolist price. And low and behold, we find that the monopolies is charging quite a lot for every passenger using this system. Maybe it's charging $20 for everyone who rides the system, the train, or the underground, or the subway, or whatever the system is. From an equity perspective, we might be concerned about this because the price is very high. But we should also be concerned from an efficiency perspective because clearly, we're not producing the efficient quantity. We know that for efficiency, we want to produce where marginal benefit is equal to the marginal cost. And we know that the marginal benefit curve is the demand curve. So the point where marginal benefit equals marginal cost, is this quantity here. This is the efficient quantity. And the monopolist cuts back, produces less, and therefore we have deadweight loss. We can see the deadweight loss on the graph, it's the difference between what the efficient quantity is and what the monopoly is producing and between the marginal benefit curve and the marginal cost curve. So the deadweight loss is this triangle here. So the problem with a natural monopoly is that we really only want to have one firm in place because it doesn't make sense to have two systems of subways or two systems of buses running on the same routes. On the other hand, if we have a monopolies, they use their monopoly power, they cut back on production, and they jack up the prices. They are inequitable and they created deadweight loss. So let's try and think of a couple of solutions. How can we have one firm in the market and nonetheless achieve as close as possible to the efficient outcome?