A natural monopoly
A) faces more competition after regulation.
B) might exaggerate its costs if it is regulated using rate of return regulation.
C) might falsely minimize its costs if it is regulated using rate of return regulation.
D) might falsely minimize its costs if it is regulated using a marginal cost pricing rule.
E) is allowed to maximize its profit under a marginal cost pricing rule.

Question

Quizplus · Accepted Answer

A natural monopoly has the ability to produce at a lower cost compared to competitors due to its large economies of scale. When it is regulated using rate of return regulation, it might exaggerate its costs to earn a higher rate of return on its investment. This could lead to higher prices for consumers and inefficient allocation of resources. Hence, option B is the best choice. Options C, D, and E do not accurately describe the behavior of natural monopolies under different types of regulation. A natural monopoly would not minimize its costs falsely if it is regulated using a marginal cost pricing rule, as it would be required to charge a price equivalent to its marginal cost of production.

A Natural Monopoly