What is the economic reason behind the regulation of public utilities? What do we usually assume...

What is the economic reason behind the regulation of public utilities? What do we usually assume about the cost structure of public utilities?

Expert Solution

For most of the public utilities, start up cost is extremely high. However the per unit cost declines as more and more service is rendered to a large population. This indicates that the fixed cost is very high but average total cost declines continuously while marginal cost is minimal.

If public utilities are not regulated, they can acquire Monopoly power because they are the only one in a market providing the service to such a large number of people. When this happens the price charged is it relatively higher then what socially efficient outcome determines. In this case public utilities will be earning significant profits and would not be working for the welfare of the people.

Due to this reason they are regulated and their price is equal to the average cost or marginal cost of production. This increases the welfare of the society as a whole. Consumers now pay a lower price and more number of people are served.

Rahul Sunny answered 1 year ago

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