notable exceptions, private ownership with regulation has been the
preferred alternative.
Whether the government owns or merely regulates natural monopolies,
the industry’s pricing policy is determined by the government or its
appointed agents. The industry is typically required to follow some
pricing policy that conflicts with the goal of profit maximization. We will
see that such government intervention must deal with problems that arise
in the short run, the long run, and the very long run.
Short-Run Price and Output
Three general types of pricing policies exist for regulated or government-
owned natural monopolies: marginal-cost pricing, two-part tariffs, and
average-cost pricing. We discuss each in turn.
- Marginal-Cost Pricing
Sometimes the government dictates that the natural monopoly set a price
where the market demand curve and the firm’s marginal cost curve
intersect. This policy, called marginal-cost pricing, leads to the allocatively
efficient level of output. This is not, however, the profit-maximizing
output, which is where marginal cost equals marginal revenue. Thus,
marginal-cost pricing sets up a tension between the regulator’s desire to
achieve the allocatively efficient level of output and the firm’s desire to
maximize profits.