A natural monopoly forms when:

a. Small firms merge to form larger firms,

b. One firm has control over the entire supply of a basic input required to produce the product,

c. One firm's monopoly position is created and enforced by the government,

d. One firm receives patent protection for certain basic production processes,

e. The long-run average cost incurred by a firm declines as the firm expands output.

• The correct answer is e. The long-run average cost incurred by a firm declines as the firm expands output.

A natural monopoly is a type of market structure that usually requires a very high initial investment. This high initial investment makes it very costly and inefficient to have multiple firms in the market. Additionally, a single firm might decrease the average cost of production with an increase in the output level. That is to say, expanding production helps to achieve lower unit costs. That is the reason why a natural monopoly has a declining average cost curve and it is more efficient to have only one firm in the market. Therefore, the correct answer is option e.

On the other hand, option a. is incorrect because the merger of small firms does not form a natural monopoly. Option b. is incorrect because that would be a description of a monopoly. Option c. is also incorrect because only a pure monopoly might be protected by government regulations (such as intellectual property rights). Option d. is also incorrect because a patent is not a reason to form a natural monopoly.