A Theory of Natural Market Structures: Regulation, R&D, FDI, International Trade and A Few Curiosities

Abstract

The theories of natural market structures have been well known in economics for a long time. In this paper, a framework for such natural market structures is developed, where natural monopoly, natural oligopoly, perfect competition and monopolistic competition are special cases. The paper explains why with increasing returns to scale at the level of the firm; a given market size; a continuum of firms; complete information and homogeneous goods, there is usually a margin for regulation -most notably when the number of firms in the market is low. The paper shows that R&D, FDI and trade liberalization can improve welfare, and that they can be complements or imperfect substitutes to the need for market regulation. It is argued that when markets are expected to grow, or technologies to change, avoiding policies that prevent entry of firms -such as licences- can reduce significantly the need for regulation while allowing for a more efficient allocation of resources. It is also argued that the need for market regulation can be better explained by the exploitation of economies of scale, than by the existence of economic rents. Finally, the paper shows that when there is a discrete number of firms, the level of profits and the regulatory margins, can be described by a "saw".