Ideally Regulated Pricing

If P = MC is such a good thing. why shouldn’t the regulators force the monopolist to lower price until it equals marginal cost at the intersection point of the DD and MC curves (at I)? . Actually. marginal-cost pricing where P = MC is the ideal target for economic efficiency. But it presents a serious practical obstacle If a firm with eliding average cost sets price equal to marginal cost, it incur a chronic loss. The reason is that if AC is falling. then MC AC, so setting P = MC implies having P < AC. When price (or average revenue) is less than average cost, the firm is losing money. To see this point visually, examine the ideal solution at point I in Figure 17-2. At that point, equals marginal cost, but At C is less than average cost. When average cost is greater than price, the firm is losing money. Since firm’s will not operate at a loss for long, and governments are reluctant to subsidize monopolists, the ideal regulatory solution is rarely pursued.

In an alternative approach, pricing is based 011 two-part tariffs. The firm charges a fixed ‘fee (say, a few dollars a month) to cover the overhead costs and then adds a variable cost (per phone call, unit of electricity, or whatever the commodity is) to cover the marginal cost. This approach can come even closer to the ideal marginal-cost pricing than does traditional average cost pricing.

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