Answer
One problem that comes up when regulators tell a natural monopoly to set its price equal to marginal cost is that the monopoly could lose money.
Natural monopolies have declining average total cost curves. Since the average total cost declines, the marginal cost is less than the average total cost. If the government forced the monopoly to set its price equal to marginal cost, the price would be less than the average total cost, and the monopoly would lose money. (Since the monopoly would lose money, the monopoly would not have any incentive to stay in the industry and thus exit the industry.)
Work Step by Step
Another problem that arises from regulators telling natural monopolies to set price equal to marginal cost is that of taking away the monopolist's incentive to reduce costs. Usually, lower costs mean higher profits in an industry. However, if the monopolist knows that the government will force prices lower if costs are lowered, the monopolist has no incentive to reduce costs.
