To produce the socially optimum level output, the regulator would set price equal to

• A. Marginal Cost
• B. Average Total Cost
• C. Marginal Revenue
• D. A price determined by the regulator with a subsidy to cover losses

Answer: (A)

The main idea is allocative efficiency: produce each additional unit as long as the value to consumers from that unit (marginal benefit) equals the cost to society of producing it (marginal cost). To reach the socially optimum output, the regulator should set price equal to the marginal cost of the last unit produced. When price equals marginal cost, the quantity produced is where MB = MC, ensuring the social value of the output matches its social cost.

If price were higher than marginal cost, too few resources would be allocated to production, and if price were lower, too many would be produced. In regulated industries, MC can be below average total cost, which would imply losses, so subsidies might be used to allow P = MC to hold while keeping the firm viable. Pricing at average total cost would not align price with marginal cost and thus would not achieve the social optimum; pricing at marginal revenue would lead to a profit-maximizing output rather than the welfare-maximizing one.