What is an average cost pricing rule? Why do regulatory agencies ...

[nevelica]

What is an average cost pricing rule? Why do regulatory agencies use it for natural monopolies?
 
  What will be an ideal response?

Question 2

Mike is a college student who works part time and earns 100 per week. He spends his entire income on two goods: pepperoni pizzas and bottles of soda. The price of a pepperoni pizza is 10 and the price of a bottle of soda is 2 .
 
  What is the opportunity cost of a pepperoni pizza? What is the opportunity cost of a bottle of soda?

[orangecrush]

Answer to Question 1

Average cost pricing means that the firms will equate their price to their average cost. It is used by regulatory agencies, because if a natural monopoly is forced to charge a perfectly competitive price (using a marginal cost pricing rule), the firm will not be able to cover its costs. No firm can operate on losses, so average cost pricing is considered a second-best solution: it allows the natural monopoly to make zero economic profit but does not allow it to set its price as high as it would were it unregulated.

Answer to Question 2

The opportunity cost of a pepperoni pizza is 5 bottles of soda. The opportunity cost of a bottle of soda is 1/5 of a pepperoni pizza.