e company's output in the form of fixed quantity contracts for purchasers of the firm's output.
2. Public utilities are usually considered to be natural monopolies. They are usually subject to regulation by state regulators intended to control the profits the natural monopoly is permitted to earn. A natural monopoly is a situation in which, for technical or social reasons, a single company can supply the entire market more efficiently than two or more firms can. Natural monopolies often occur as a result of the fundamental cost structure of the industry or high dollar costs associated with entry into the industry. For example, in the delivery of utilities, it would be difficult for a business to justify the substantial up front costs in infrastructure needed to deliver products such as water and electricity of that public utility did not have a reasonable expectation that it would receive an adequate return on investment. Legislators and the general public believe that the best way to ensure that public utilities earn an adequate return on investment but do not use their position in the marketplace to increase prices in order to generate exceptionally high profit margins is for these natural monopolies to be regulated. Regulatory entities typically work closely with public utilities and balance the needs of the public utility as a business with the expectations of the general public.
When the price a public utility can charge is regulated, producers have an incentive to maximize their profits by reducing costs. The argument in favor of pricing of public utility products at average cost is that all cash outlays by the utility that would have been avoided if a product had not been produced and delivered will be recovered in the price charged by the utility. An average cost pricing policy ensures that a utility will break even or show a profit whether it is exceptionally inefficient or conversely exceptionally efficient. The im...