Final answer:
Economic regulators regulate prices for natural monopolists to prevent high consumer prices and limited output due to the absence of effective market competition in such industries. Price cap regulation is employed delicately, balancing the need to cover costs and prevent consumer exploitation. Regulation serves to simulate competitive market outcomes and protect consumer interests.
Step-by-step explanation:
Economic regulators may regulate prices charged by natural monopolists because the nature of these monopolies prevents the typical market forces of entry and exit from being effective in reducing prices. A natural monopoly occurs in industries where the cost structure favors a single provider, such as in the provision of water or electricity. Therefore, without regulation, these monopolies could charge high prices and produce below the socially optimal output.
Regulatory bodies use price cap regulation to prevent these outcomes. However, setting these price caps can be challenging; they need to be high enough to cover costs and allow for a reasonable profit but not so high as to exploit consumers. Additionally, regulators can provide incentives for efficiency and innovation by allowing the natural monopoly to earn greater profits or experience losses, rather than fixing profit rates.
Ultimately, regulation aims to mimic market competition outcomes and protect consumers. It is necessary in the context of natural monopolies where market mechanisms alone cannot guarantee consumer-friendly pricing and sufficient industry output.