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Perfect Competition versus Pure Monopoly 333

the lower average-cost-based price spurs a significant increase in output and,

therefore, in welfare.

However, average-cost pricing does not exhaust the opportunities for wel-

fare gains. At output QR8, the demand curve still lies above marginal cost;

that is, MB MC. Output should be expanded and price lowered. In fact, opti-

mal price and output can be determined by the intersection of the demand

and marginal cost curves. This outcome is referred to as marginal-cost pricing

because it fulfills the efficiency condition P MB MC. Consumers are

encouraged to purchase more output as long as their value exceeds the (low)

marginal cost of production.

If marginal-cost pricing is efficient, why isn’t it universally used? The prac-

tical difficulty with this pricing scheme should be evident. Price falls short of

the firm’s declining average cost P MC AC—so the firm makes persist-

ent losses. One way to maintain P MC while making good this loss is to have

FIGURE 8.4

A Natural Monopoly

Regulators seek to

implement average-

cost pricing where the

demand curve

intersects the AC curve.

PM = 6

Q

Electricity (Kilowatt-Hours)

Dollars per Unit of Output

Electricity

demand

PR = 3

Monopoly outcome:

PM = $6, QM = 5

Declining

average

cost

10

MC

9

8

7

5

4

MC = 1

2

11

0 123456789

Average-cost

pricing under

regulation

10 11

Marginal

revenue

$12

12

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