Why would it be economically efficient to require a natural monopoly to charge a price equal...

Why would it be economically efficient to require a natural monopoly to charge a price equal to marginal cost? Why do most regulatory agencies require natural monopolies to charge a price equal to average cost instead?

Expert Solution

When the price is set equal to the marginal cost that is socially efficient because the prices will be low and the quantity produced will be high. But this is not at all good for the firm, if the price is set at the marginal cost the firm would be getting the negative economic profit, and this may lead to shutting down the natural monopoly. This is not good for the society, so the firm would enact the average cost pricing rather than the marginal cost pricing. The natural monopoly has the decreasing average cost so this pricing strategy allows to them obtain little bit of profit.

When the price is set at the marginal cost the firm would incur losses , the average cost of the lies above the price. So the firm would be suffering losses, here the government will give a subsidy to the government other wise the firm will be out of the business.

And if the price is set at the average cost, the firm would be earning the normal profits initially , this pricing allows the firm to survive in the market.

Rahul Sunny answered 1 year ago

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