Socially optimal liability rules for firms with natural monopoly in contestable markets

► We model contestable markets with natural monopoly due to decreasing average cost. ► We examine the welfare effect of liability rules for firms. ► If the fixed cost that pushes the entry-limiting price above marginal cost is large relative to the level of external harm of firms, the negligence regime is socially superior to the strict liability regime. ► In the opposite case, the strict liability rule may be socially superior.