What is an average cost pricing rule? Why do regulatory agencies use it for natural monopolies?
What will be an ideal response?
Average cost pricing means that the firms will equate their price to their average cost. It is used by regulatory agencies, because if a natural monopoly is forced to charge a perfectly competitive price (using a marginal cost pricing rule), the firm will not be able to cover its costs. No firm can operate on losses, so average cost pricing is considered a second-best solution: it allows the natural monopoly to make zero economic profit but does not allow it to set its price as high as it would were it unregulated.
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