Regulation
Natural Monopolies
• Breaking up a monopoly that isn’t
natural is a good idea
– Ex. Microsoft buying Apple
• Why?
• The gains to the consumer outweigh the
loss to the producer
Natural Monopolies
• A monopoly in which large producers have
lower average total costs than small
producers
• Should these be broken up?
• If they do, it would raise total costs
• Ex. Small town government tries to prevent
a single company from dominating local gas
supply – if it does, the cost of providing gas
to its residents would raise
Increasing Returns to Scale Create Natural Monopoly
Price,
cost
Natural monopoly.
Average total cost is
falling over the relevant
output range
Natural monopolist’s
break-even price
ATC
D
Quantity
Relevant output range
Natural Monopolies
• With all monopolies, even natural
monopolies, a profit-maximizing
monopolist acts in a way that causes
inefficiency
• Consumers are charged a price that is
higher than marginal cost and by doing so,
prevents potential beneficial transactions
• How can better economic outcomes be
established?
• Through public policy and public regulation
Public Ownership
• The good is supplied by the government or by
a firm owned by the government
– Ex. Amtrak, U.S. Postal Service, mass transit,
water supply systems and garbage collection at
local levels
• Advantage of this: a publicly owned natural
monopoly can set prices based on the
criterion of efficiency rather than profit
maximization
• Disadvantage: less eager than private
companies to keep costs down
Price Regulation
• Also known as industrial regulation
• Limits the price that a monopolist is
charged
Commission
(Year Established)
Jurisdiction
Federal Energy Regulatory
Commission (1930)
Electricity, gas, gas pipelines, oil
pipelines, water-power sites
Federal Communications Commission
(1934)
Telephones, television, cable
television, radio, telegraph, CB radios,
ham operators
State public utility commissions (50
states)
Electricity, gas, telephones
Price Regulation
• Public interest theory of regulation
states that industrial regulation is
necessary to keep a natural monopoly
from charging monopoly prices and thus
harming consumers and society
• Regulators seek to establish rates that
will cover production costs and create a
“fair” return to the price
REGULATED MONOPOLY
Natural Monopolies
Rate Regulation
Socially Optimum Price
P = MC
Fair-Return Price
P = ATC
Dilemma of Regulation
REGULATED MONOPOLY
Monopoly Price
MR = MC
Price and Costs
P
Pm
ATC
MC
D
MR
Qm
Q
REGULATED MONOPOLY
Price and Costs
P
Fair-Return Price
Normal Profit Only
ATC
MC
Pf
D
MR
Qf
Q
REGULATED MONOPOLY
Price and Costs
P
Socially-Optimum
Price
P = MC
ATC
MC
Pr
D
MR
Qr
Q
REGULATED MONOPOLY
Dilemma of Regulation
MR = MC Which Price?
Fair-Return Price
Price and Costs
P
Pm
Socially-Optimum
Price
ATC
MC
Pf
Pr
D
MR
Qm
Qf
Qr
Q
Costs and Inefficiency
• Unregulated firms have an incentive to
reduce its costs at each level of output
because it will increase its process
• Regulatory commission confined the
regulated firm to a normal profit or “fair
return” on the value of its assets
• Regulated firm has little or no incentive to
reduce its operating costs
Perpetuating Monopoly
• Problem with industrial regulation is that it
perpetuates monopoly long after the
conditions of natural monopoly have ended
• What creates this?
• Technological change
– Trucks verse railroads, cell phones verse land
lines
• Commissions set up to regulate
– Protect regulated monopolies from new
competition by blocking entry or extending
regulation
Legal Cartel Theory
• Some industries seek regulation or want to
maintain regulation in order to
form/maintain a legal cartel
• Why?
• It can guarantee a profit
• How?
• Blocking entry
• Illegal?
• Private cartels are, govern-sponsored cartel
under regulation are not
Deregulation & Social Regulation
• Deregulation has produced large net benefits
for consumers and society
• Specifically, airlines, railroads and trucking
• Also in long-distance telecommunications,
cable television
• Deregulation of electricity has been a success
with a few setbacks
Social Regulation
•
Commission
Jurisdiction
Is not(Year
concerns
with natural monopolies but
Established)
with good
and
services produced,
the impact
Food and
Drug
Safety and effectiveness
of
Administrationon
1906
and cosmetics
of production
societyfood,
anddrugs,
the physical
Equal Employment
Hiring, promotion, and
qualities
of the goods themselves
Opportunity Commission
discharge of workers
1964
Occupational Safety and
Industrial health and safety
Health Administration 1971
Environmental Protection
Air, water, and noise
Agency 1972
pollution
Consumer Product Safety Safety of consumer products
Commission
Social Regulation vs. Industrial
Regulation
1. Applies to more firms, applied “across the
board” to all industries and affects more
producers
2. Intrudes into the day-to-day production
process
– Ex. EPA
3. Social regulation expanded when industrial
regulation waned
Optimal Level of Social Regulation
• What is the optimal level?
• Remember, it is recommended for any
industry/firm to have it MB exceed its MC
• If the MB of social regulation exceeds MC,
too little social regulation
• If MC exceed MD, too much!
So, is there a free lunch?
• Social regulation can produce higher prices,
stile innovation, and reduce competition
• But, less government intervention is not
always better than more government
Regulation Notes
Natural Monopolies
• Breaking up a monopoly that isn’t
natural is a good idea
• Why?
• The gains to the ____________outweigh
the loss to the ____________
Natural Monopolies
• A monopoly in which large producers
have lower average total costs than
small producers
• Should these be broken up?
• If they do, it would raise ____________
• Ex.
Increasing Returns to Scale Create Natural Monopoly
Price,
cost
Natural monopoly.
Average total cost is
falling over the relevant
output range
Natural monopolist’s
break-even price
ATC
D
Quantity
Relevant output range
Natural Monopolies
• With all monopolies, even natural
monopolies, a profit-maximizing
monopolist acts in a way that causes
____________
• Consumers are charged a price that is
higher than marginal cost and by doing so,
prevents potential beneficial transactions
• How can better economic outcomes be
established?
Public Ownership
• The good is supplied by the government or by
a firm owned by the government
– Ex.
• Advantage of this: a publicly owned natural
monopoly can set ____________ based on
the criterion of ____________ rather than
profit ____________
• Disadvantage:
Price Regulation
• Also known as ____________ regulation
• Limits the price that a monopolist is
charged
Commission
(Year Established)
Jurisdiction
Federal Energy Regulatory
Commission (1930)
Electricity, gas, gas pipelines, oil
pipelines, water-power sites
Federal Communications
Commission (1934)
Telephones, television, cable
television, radio, telegraph, CB
radios, ham operators
State public utility commissions
(50 states)
Electricity, gas, telephones
Price Regulation
• Public interest theory of regulation
states that ____________ ____________
is necessary to keep a ____________
____________ from charging monopoly
prices and thus harming consumers and
society
• Regulators seek to establish rates that
will cover production costs and create a
“____________” return to the price
REGULATED MONOPOLY
Natural Monopolies:
Rate Regulation
1. Socially Optimum Price
• ____________
2. Fair-Return Price
• ____________
Dilemma of Regulation
REGULATED MONOPOLY
Monopoly Price
____________
Price and Costs
P
Pm
ATC
MC
D
MR
Qm
Q
REGULATED MONOPOLY
Price and Costs
P
Fair-Return Price
Normal Profit Only
ATC
MC
Pf
D
MR
Qf
Q
REGULATED MONOPOLY
Price and Costs
P
Socially-Optimum
Price
____________
ATC
MC
Pr
D
MR
Qr
Q
REGULATED MONOPOLY
Dilemma of Regulation
MR = MC Which Price?
Fair-Return Price
Price and Costs
P
Pm
Socially-Optimum
Price
ATC
MC
Pf
Pr
D
MR
Qm
Qf
Qr
Q
Costs and Inefficiency
• Unregulated firms have an ____________ to
reduce its costs at each level of output
because it will increase its process
• Regulatory commission confine the regulated
firm to a normal profit or “____________” on
the value of its assets
• Regulated firm has little or no ____________
to ____________ its operating costs
Perpetuating Monopoly
• Problem with industrial regulation is that it
perpetuates monopoly long after the
conditions of natural monopoly have ended
• What creates this?
• ____________ ____________
– Ex.
• ____________ set up to ____________
– Protect regulated monopolies from new
competition by blocking entry or extending
regulation
Legal Cartel Theory
• Some industries seek regulation or want to
maintain regulation in order to
form/maintain a legal cartel
• Why?
• ________________________
• How?
• ________________________
• Illegal?
• Private cartels are, govern-sponsored cartel
under regulation are not
Deregulation & Social Regulation
• Deregulation has produced large net benefits
for ____________ and ____________
• Specifically, ________________________
• Also in long-distance telecommunications,
cable television
• Deregulation of electricity has been a success
with a few setbacks
Social Regulation
• Is not concerns with natural monopolies but
with ____________ and ____________
produced, the impact of production on
____________ and the physical qualities of
the ____________ themselves
Social Regulation
Commission
(Year Established)
Jurisdiction
Food and Drug
Safety and effectiveness of
Administration 1906
food, drugs, and cosmetics
Equal Employment
Hiring, promotion, and
Opportunity Commission
discharge of workers
1964
Occupational Safety and
Industrial health and safety
Health Administration 1971
Environmental Protection
Air, water, and noise
Agency 1972
pollution
Consumer Product Safety Safety of consumer products
Commission
Social Regulation vs. Industrial
Regulation
1. Applies to more firms, applied “across the
board” to all industries and affects more
producers
2. Intrudes into the day-to-day production
process
– Ex. ______________________
3. Social regulation expanded when industrial
regulation waned
Optimal Level of Social Regulation
• What is the optimal level?
• Remember, it is recommended for any
industry/firm to have it ______ exceed its
______
• If the ______ of social regulation exceeds
______, too little social regulation
• If ______ exceed ______, too much!
So, is there a free lunch?
• Social regulation can produce ______ prices,
little ____________, and reduce
____________
• But, less government intervention is not
always better than more government