What would happen if we allowed a firm in this setting to operate as a monopoly without regulation? Suppose the firm faces demand shown by D to the right. If unregulated, it will produce the quantity QM where marginal revenue = marginal cost (MR=MC) and charge the profit maximizing price PM. The argument for allowing the firm to be a monopoly was lower costs and prices, but without regulation prices will be very high.
If the firm is regulated so as to operate in an allocatively efficient manner, it must operate where price = marginal cost (P=MC). Output would be QAE, and price would be PAE. This is appealing from an efficiency standpoint, but it turns out to be impractical.
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