|Regulation of Natural Monopoly
under single vs discriminating pricing
When economy of scale results in a natural monopoly with a persistently declining ATC, the single-pricing firm faces difficult choices. If the firm produces where MRsp = MC, price would be too high and output too low to reap the benefit of scale economy. But if Psp is set equal to MC when ATC is declining, Psp would be lower than ATC leading to economic loss for the natural monopoly. Government-imposed average-cost pricing would increase output beyond where MRsp = MC but the firm would earn just zero economic profit.
Even when the firm is not making any economic profit at Psp = ATC, it is still not producing at the socially optimal output where MB = MC.
Under price discrimination, the firm would be producing where MRdp = MC with positive economic profit and MB = MC because MRdp = Pdp.
Even if ATC is entirely above the demand curve where not even a single-pricing monopoly would want to produce, price discrimination could still ensure profit for the natural monopoly without any government regulation.