ECONOMIC REGULATION: Controlling price
and other aspects of competition
GOAL: Prevent monopoly pricing
Antitrust/Competition law
Public Utility Regulation
• Acquisition of pricesetting power
• chartered monopoly
• Collusion to fix price
• Use of market power
unfairly or unreasonably
to squelch competition
• administrative price
setting
Government Ownership
Economic Regulation: Evolution of Legal Rules
1792
Tripp v. Frank (England)
1837
Charles River Bridge (U.S.)
1859
Edwin Drake struck oil in western Pennsylvania
1865
First natural gas utility opened in Fredonia, NY
1877
Munn v. Illinois
1882
Edison’s Pearl St. Station power plant opened
1887
Interstate Commerce Act
1880s1930s
Rise of state utility commissions; passage of
federal major antitrust legislation
1930s
Federal Power Act; Rural Electrification Act; Public
Utilities Holding Co. Act
Monopolization
• Under §2 of the Sherman Act, it is illegal
to monopolize or attempt to monopolize.
• To tell if a monopoly is illegal, ask:
– What is the market?
– Does the company control the market?
• No matter what your market shares, you do
not have a monopoly unless you can exclude
competitors or control prices.
Monopolization
How did the Standard Oil acquire its
dominant share in the oil market?
•
Originally, Standard Oil professionalized and
improved the quality of the oil refining business
•
This increased the cost of entry
•
Rockefeller excelled at eliminating waste and
minimizing costs while maintaining quality.
Monopolization
How did the Standard Oil maintain its dominant
share in the oil market?
•
Negotiated “rebates” from railroads. Why
rebates? Why not just reduced rates?
•
Consolidation plan
• buyouts +/or
• South Improvement Company
What exactly was the SIC? How did it work?
•
Shipping/transportation control
•
Vertical integration (upstream; downstream)
Artifacts of Standard Oil: U.S. antitrust laws prohibit
– price fixing / collusion
– geographic market divisions
– maintenance of a monopoly through “bad
acts”
– certain forms of price discrimination
– certain forms of resale price maintenance
– mergers that will create firms with “monopoly
power”
Antitrust Law
Illegal
monopolization
Illegal
restraints
of trade
Sources of Confusion in Antitrust Law
•
Changing philosophies over time:
– Movement away from presuming harm to
consumer (per se violations) and toward
requiring government/plaintiff to prove harm
(increasing application of rule of reason)
– Movement towards greater focus on effect on
consumer in the long run
– Because these philosophical changes are new,
different judges seem to apply different
approaches, depending upon whether they
subscribe to the old or the new philosophy
– DOJ/FTC enforcement policies vary according to
the preferences of the presidential administration
Economic Regulation: Evolution of Legal Rules
1792
Tripp v. Frank (England)
1837
Charles River Bridge (U.S.)
1859
Edwin Drake struck oil in western Pennsylvania
1865
First natural gas utility opened in Fredonia, NY
1877
Munn v. Illinois
1882
Edison’s Pearl St. Station power plant opened
1887
Interstate Commerce Act
1880s1930s
Rise of state utility commissions; passage of
federal major antitrust legislation
1930s
Federal Power Act; Rural Electrification Act; Public
Utilities Holding Co. Act
Inefficiency of Monopoly
Price
PM
MC
PC
MR
QM
D
QC
Quantity
Commission Regulation
COMMISSION FORM:
•
Plural executive; appointed (feds) or elected (some
states)
•
Rate cases; few rulemakings
•
“Staff” represents ratepayers
CONGRESS
Staff
COMMISSION
Intervenors
Regulated Firms
PRESIDENT
Commission Regulation
COMMISSION FORM:
•
Plural executive; appointed (feds) or elected (some
states)
•
Rate cases; few rulemakings
•
“Staff” represents ratepayers
REGULATORY PRINCIPLES:
1. “Natural” monopoly; certificate of convenience and
necessity; duty to serve
Commission Regulation
COMMISSION FORM:
•
Plural executive; appointed (feds) or elected (some
states)
•
Rate cases; few rulemakings
•
“Staff” represents ratepayers
REGULATORY PRINCIPLES:
1. “Natural” monopoly; certificate of convenience and
necessity; duty to serve
2. Cost-based rate setting; “fair” rate of return for
shareholders on “prudent” investments
How might this “fair” return be established?
PUBLIC POWER MOVEMENT
1. Federal Power Agencies (TVA, BPA)
2. REA
3. Municipal power
4. Federal and municipal preferences
5. California in 2002?
Characteristics of modern, regulated public
utility:
• Monopoly license within service area
• Duty to serve all
• Regulated rates
• Under traditional rate regulation, how are
rates set?
R = Br + O
• What is a rate case? Procedurally, how does
a rate case unfold? Who initiates it, and who
else is involved?
R = Br + O
What is “rate base”?
• Is all utility capital equipment included?
• Once the eligible assets are identified, how is
a value assigned to that rate base?
• Suppose the state PSC miscalculates the
value of a generating plant, overvaluing it by
30%?
R = Br + O
• What is the rate of return?
• What sort of rate of return is the utility
entitled to? What policy objectives underlie
the requirement of a “fair” return on
investment?
• How is this standard applied? How is the
rate set?
R = Br + O
• How closely do regulators scrutinize
expense claims made by utilities?
• What if the expenses were incurred
imprudently?
• How are expenses calculated?
I.
TEXAS LIGHT AND POWER:
Item
Original cost($000)
Year
Transmission facilities
$1000
1995
Coal-fired plant
$10K
Rarely used solar plant
$1000
1995
Cancelled nuclear plant
$1000K
1995
Construction on new hydro plant
$1000/yr.
Railroad spur for coal delivery
$100
Assets of env consulting subsidiary
$1000
Research into fusion power
$1000
PURPA era hydro purchase contracts
$100/yr.
Executive salaries
$1000/yr.
Attorney’s fees
$1000/yr.
Contribution to Ch. of Scientology
$100/yr.
Contribution to local food bank
$100/yr.
1
1965
Since 1995
1995