Average cost pricing is a rule under which price is set equal to average total cost so that a producer covers its costs without making excess profit.
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The pricing rule
The core condition is:
$$ P = AC $$
This is often discussed in regulated industries or natural monopolies where marginal-cost pricing would leave the firm unable to cover its fixed costs.
Why economists care
Average cost pricing is a compromise. It avoids chronic losses, but it is generally less efficient than marginal-cost pricing because price remains above marginal cost. That means some mutually beneficial trades may not occur.
Where it is used
The rule is most relevant in utilities and network industries where high fixed costs make pure marginal-cost pricing financially unsustainable without subsidy.
Related Terms
Knowledge Check
### Average cost pricing sets price equal to:
- [x] average total cost
- [ ] marginal revenue
- [ ] fixed cost only
- [ ] average tax rate
> **Explanation:** The rule is designed to let the firm break even overall.
### Why might regulators use average cost pricing?
- [x] Because a firm with high fixed costs may not survive if price equals marginal cost
- [ ] Because efficiency never matters
- [ ] Because all firms are natural monopolies
- [ ] Because prices should always exceed demand
> **Explanation:** Break-even pricing can matter in industries with large infrastructure costs.
### Compared with marginal-cost pricing, average-cost pricing is usually:
- [x] less efficient but more financially self-sustaining
- [ ] always more efficient
- [ ] impossible to implement
- [ ] unrelated to regulation
> **Explanation:** It trades some efficiency for cost recovery.