Chapter 4 was concerned with the technological conditions for the existence of natural monopoly. This and the following three chapters will deal with some of the economic issues associated with natural monopoly. Perhaps the most important one to be addressed is the role that competition by rival firms should play in an industry that is considered a natural monopoly. That is, should there be open and unrestricted entry into some or all of the natural monopolist's markets?

Given the discussion in Chapter 4, it may seem strange to pose the preceding question, for a natural monopolist is by definition more efficient than any collection of firms that could result from effective entry by rival firms. However, it should be remembered that the condition of cost subadditivity, although easy to state, is by no means simple to verify in practice. By the very nature of subadditivity, which requires comparison of a single firm's costs with an infinity of alternatives, no regulator can be entirely certain that the firm that it regulates is a natural monopoly. Potential rivals will not generally accept the monopolist's claims of subadditivity if they perceive that there is profit to be made upon entry into the industry. Even monopolists cannot be entirely sure that their position is a natural monopoly.

The purpose of this chapter will be to point out some surprising and potentially serious consequences of a policy of free entry into natural monopoly markets.