One difficulty associated with average cost pricing regulation of natural monopolies is that firms have little or no incentive to minimize production costs.

Question

Quizplus · Accepted Answer

Natural monopolies have high fixed costs and low marginal costs, making it difficult for new firms to enter the market. Therefore, the existing firm does not face any competition and can charge a higher price than the efficient cost. In an average cost pricing regulation, the regulator sets the price equal to the average cost of production to prevent the firm from earning excessive profits. But, the firm has no incentive to reduce its production costs, as it can pass on any cost increases to consumers by raising prices up to the regulated level. This can result in higher prices for consumers without any corresponding efficiency improvements in production costs.

One Difficulty Associated with Average Cost Pricing Regulation of Natural