Public Utility Pricing:

Public Utility is the common term for a  firm that provides an important (what some deem as essential) good or service often through the use of an extensive distribution network. A key feature of public utilities is  that due to huge fixed capital requirements these tend to be natural monopolies. Thus there is a natural tendency for concentration/centralization in such cases.

A natural monopoly is able to lower its price when it produces and sells a larger quantity. This somewhat remarkable ability results because a natural monopoly uses a great deal of capital. In that capital carries an up-front (sunk) cost that must be paid regardless of production. A natural monopoly can spread these costs over larger quantity if it produces more. Consequently, the formal representation of a natural monopoly starts with falling average and marginal costs with rising output levels. A single natural monopoly is thus able to produce and supply a good at a lower cost, and therefore price, than two or more firms.  

These big public utilities can generally provide the services at a lower average cost than the small ones. To exploit this potential and to restrict the public utilities from practicing monopoly pricing, in many cases, theses firms tend to be either government owned and operated or heavily regulated by government. Under government control the firms practise 'average cost pricing' rather than 'marginal cost pricing'.

To understand the problems with these public utilities we need to discuss their price-output determination mechanisms. The pricing processes provide vital clues for our specific analysis.