In Figure 27.2, regulation designed to achieve allocative efficient pricing for the natural monopoly will result in a price of

Question

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In the diagram, S1 is the socially optimal output level which corresponds to P1. However, at this quantity, the natural monopoly incurs losses due to its high fixed costs. Therefore, regulation is needed to allow the firm to earn a normal profit at the socially optimal quantity. This is achieved by setting a price of P0, which is equal to the average total cost at the quantity where the firm earns zero economic profit, i.e., the intersection of the marginal cost (MC) and average total cost (ATC) curves. Therefore, the allocatively efficient price is ^PA.