← Market structures and marginal analysis
Natural monopoly: comparing the three pricing options
Unregulated (profit-maximising), average-cost, and marginal-cost pricing recur every year as a single three-way comparison — learn them as one table, not three separate facts.| Pricing rule | Price/output | Profit | Allocative efficiency |
|---|---|---|---|
| Unregulated (MR = MC) | Highest price, lowest output of the three | Maximum economic (supernormal) profit | Least efficient — largest deadweight loss |
| Average-cost pricing (P = AC) | Middle price and output | Normal profit only (zero economic profit) | Better than unregulated, but still P > MC |
| Marginal-cost pricing (P = MC) | Lowest price, highest output of the three | Often a LOSS, since AC may exceed MC at this output | Fully allocatively efficient — P = MC |
Marginal-cost pricing is the most allocatively efficient but can leave the firm unable to cover its average costs — this trade-off is exactly what a "which pricing option leaves the firm/consumers best or worst off" question is testing.
✕Assuming the most efficient price is always the best policy choice
Marginal-cost pricing is allocatively efficient, but if it forces the natural monopolist into a loss, the firm may exit or need a government subsidy to survive — a real trade-off, not a free win. Average-cost pricing sacrifices some efficiency but guarantees the firm at least breaks even. A strong answer names this trade-off explicitly rather than assuming "more efficient" always means "better policy".A fast check on a three-way pricing comparison
- Have I stated price, output, profit AND allocative efficiency for all three options, not just one or two?
- Have I named the specific trade-off (efficiency vs firm viability), not just described each option separately?