Question

does the monopolist have an incentive to reduce cost under average cost pricing? how can this be overcome?

Answer 1

Average cost pricing is the price that the regulators fix for the monopolies to charge from their customers and it is very close to their cost of production .The monopolist is forced to charge a price below the profit maximising level.The monopolist can earn normal profit on such situation.Monopolist have the tendency to produce less than the optimal quantity in order to increase the price.The monopolist, because of average cost pricing, are forced to reduce their prices to the point where the average total cost intersect the market demand curve. As a result of this , production in the market will increase and the price will also fall,output will be efficient and the monopolist will earn normal profit as mentioned above.Average cost pricing means the firms will make their price and average total cost equal. If the monopoly charges a perfectly competitive price the firm will face problem to cover its cost.

If monopolies are left unregulated , price fixing can take place.The regulators allow monopoly to charge a small increase in price above the cost which is known as average cost pricing and this is a perfect solution to the problem arising if monopolies are not regulated.