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2.1. The natural monopoly conundrum > 2.1. The natural monopoly conundrum - Pg. 18

18 Electricity Cost Modeling Calculations represents an irreversible investment, which is characterized by both economies of scale and those of network planning, and as such yields a natural monopoly. Because this network leads to externalities, vertical integration has traditionally yielded the most efficient organization of the industry, especially for larger firms. But, due to the vertical nature of elec- tricity production, questions have arisen concerning whether any aspect of the production process may not be a natural monopoly. And, if this is the case, the questions then become: Would the market be better served by allowing competition into that component and would the gains from competition exceed the lost economies that would result? This is the criti- cal element that needs to be explored. But things are not always so clear. While little work has been done in the areas of testing whether the transmission and distribution processes are natural monopolies, they are usually assumed to be so, since both are char- acterized by what is known as network economies. Network economies arise due to the interconnectedness of the national transmission grid, so that significant saving in inputs and direct routing yield both economies of scale and economies of scope. These are defined later in this chapter, along with