REGULATION
MBA Managerial Economics
Lecturer: Jack Wu
REGULATION
natural monopoly
 potentially competitive market
 asymmetric information
 externalities
 public goods

NATURAL MONOPOLY
Average cost minimized with single supplier
 large scale/scope economies
 relative to market demand
MARGINAL COST PRICING
Require provider
 set price equal to
marginal cost
 supply quantity
demanded
demand
marginal
cost
AVERAGE COST PRICING
Require provider
 set price equal to
average cost
 supply quantity
demanded
demand
average cost
marginal
cost
RATE OF RETURN REGULATION
maximum rate of return on rate base
 disallowed profit returned to users

POTENTIALLY COMPETITIVE MARKET
Economies of scale/scope are small relative to
market demand
 technology
 market demand
MATH EXAMPLE
Suppose that the demand for electric power is
 P=10-q. P represents price in thousand dollars
and q represents quantity in megawatt-hours.
 All generating plants have a capacity of 10
megawatt-hours.
 Generation involves a fixed cost of $50,000 and a
constant marginal cost of $1000 per megawatthour.
 Now, suppose that the demand grows to P=100.05q. How many plants would be needed to meet
the quantity demanded?

STRUCTURAL REGULATION
Bar franchise holder from vertically related
markets

prevent monopoly from extending market power
MORAL HAZARD IN MEDICINE
price ($/hour)
supply
a
b
inflated demand
true demand
quantity (million hours a mth)
RESOLVING INFORMATION ASYMMETRY
mandatory disclosure
 regulation of conduct
 structural regulation

marg. cost/benefit ($/ton)
EMISSIONS
marginal cost
to society
35
marginal benefit
to society
8000
quantity (tons/year)
marg. cost/benefit ($/ton)
EMISSIONS FEE
user fee
35
marginal benefit
to society
8000
quantity (tons/year)
ACCIDENTS
marg. cost/benefit
marginal cost
to driver
s
marginal benefit
to society
quantity (units of care)
PUBLIC GOODS

legal framework enables excludability
copyright
 patent


trade-off
incentive for knowledge creation
 economically efficient usage of information

PUBLIC PROVISION
For some public goods, practically difficult to
enforce exclusion
 national defense
 clean air
 fireworks
CONGESTIBLE FACILITIES
social marginal cost varies with usage
 resolve through user fee = social marginal cost

time
 usage

DISCUSSION QUESTION


The demand for electric power in Sol Province is
p = 20 - 20q, where p and q represent the price in
thousands of dollars and quantity in Megawatt
hours, respectively. Suppose that an electricity
plant generates power at a constant marginal
cost of $1000 per megawatt hour up to a capacity
of 10 megawatt hours. Sol Province requires the
plant to implement marginal-cost pricing.
DISCUSSION QUESTION
Illustrate the price and quantity with marginal
cost pricing.
 Suppose that demand grows to P=20-0.1q. At a
price of $1000 per megawatt hour, what is the
minimum number of plants needed to produce
the quantity demanded?
