A monopoly that does not arise from government intervention in the marketplace to protect a favored firm from competition but rather from special characteristics of the production process in the industry under the current state of technology. Theoretically, natural monopoly arises when there are very large "economies of scale" relative to the existing demand for the industry's product, so that the larger the quantity of the good a single factory produces, the cheaper the average costs per unit get -- right up to production at a level more than sufficient to supply the entire demand in the relevant market area. This might occur when production of the good requires extremely large initial capital investments to even enter the market in a modest way but then producing additional output requires only very modest additional outlays beyond the fixed initial investment. Under such circumstances, the firm that initially starts out with the largest share of the market is in a position to price its output at a level below its (higher cost) competitors' costs of production and still make a profit while driving them out of the business -- and the larger its market share gets, the lower its unit costs become, until a monopoly position is finally obtained. (It is often argued that local telephone service, natural gas supply, and electrical power distribution fall into this category because of the heavy initial investments in networks of telephone lines, electrical lines and gas lines that are involved.)

From the point of view of the rest of society, this single firm monopoly is potentially a blessing, since the one firm can in fact produce the amounts of the good they will demand at a lower total cost in resources than multiple competing firms could. However, once the firm has attained a monopoly position, there is the likelihood that it will use its unusual dominance of this market to maximize profits by restricting output below the level which a competitive market would lead to and raising prices above competitive levels. This would lower overall social welfare below the maximum theoretically achievable because price would be set above marginal costs of production. It is therefore argued by some economists that such natural monopolies represent instances of "market failure" and that this justifies government stepping in to regulate prices and output levels in such an industry so that price will more closely approximate marginal costs of production. (However, since the "natural monopolist" by definition faces a situation where his marginal costs will be lower than his average per unit costs, forcing him to accept a price equal to his marginal cost will result in his always making a loss rather than a profit from his business. Consequently, the government regulators would either have to pay the monopolist a subsidy to allow him a "fair return" on his investment or else fix the price of the product above its marginal costs of production anyway to accomplish the same end at greater social cost -- which is the usual approach taken.)