PUBLIC UTILITY REGULATION OF NATURAL MONOPOLY

A traditional economic argument for regulation is to prevent monopoly pricing by natural monopolists. Let us see exactly how regulators control excessive price increases of monopolists. Recall that a natural monopoly is an industry in which the most efficient way of organizing production is through a single firm. Figure 17-1 shows the way the AC, MC, and industry demand might look for a natural monopoly. Note .that the industry demand curve (00) intersects the where AC is falling. If two similar firms were to produce the industry output. the two firms would be well abose that of a single firm.

Second. in making the monopolist cut its price from PM to PR, the regulators have reduced the  discrepancy between price and marginal .cost. This change improves economic efficiency because the additional output is worth more to consumers in marginal utility than it costs society in terms of the marginal cost, Only when price is equal to marginal cost in all sectors is society using its resources most efficiently.

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