Question

What social issue arises if the government forces the government to lower their prices, but then offers a subsidy to the monopoly to offset their losses?

Answer 1

When regulators tell a natural monopoly that it must set price equal to marginal cost, two problems arise. The first is that, because a natural monopoly has a constant marginal cost that is less than average cost, setting price equal to marginal cost means that the price is less than average cost, so the firm will lose money. The firm would exit the industry unless the government subsidized it, but getting revenue for such a subsidy would cause the government to raise other taxes, increasing their deadweight loss. The second problem is that it gives the monopoly no incentive to reduce costs.