- Two-Part Tariff
One pricing policy that permits the natural monopoly to cover its costs is
to allow it to charge a two-part tariff in which customers pay one price to
gain access to the product and a second price for each unit consumed.
Consider the case of a regulated cable TV company or Internet service
provider (ISP). In principle, the hook-up fee covers fixed costs, and then
each unit of output can be priced at marginal cost. Indeed, many new
subscribers to cable TV or Internet service are surprised at how high the
hook-up fee is—clearly much higher than the cost of the cable guy’s half-
hour to complete the job! Yet if this fee also includes that household’s
share of the firm’s fixed costs (spread over many thousands of
households), then the large hook-up fee is more understandable.
- Average-Cost Pricing
Another approach to pricing for a natural monopoly is to set prices just
high enough to cover average costs, thus generating neither profits nor
losses. This is called average-cost pricing. The firm sets a price and
produces the level of output at which the demand curve cuts the LRAC
curve. Figure 12-8 shows that for a firm with declining long-run average
costs, this pricing policy requires producing at less than the allocatively
efficient output. The firm’s financial losses that would occur under
marginal-cost pricing are avoided by producing less output (and having
higher prices) than what is socially optimal.