Regulation Private rights versus public needs

Why Regulate? If competition cannot exist, or survive long, and an unregulated market will not produce competitive results If competition does exist, but because of imperfections in the market, competition does not produce competitive results If competitive results are unsatisfactory because of other policy considerations

Role of regulation Perform the balancing of interests that the market provides in a competitive marketplace –Interests of buyers versus sellers –Interests of subscribers versus stockholders

Changed role of regulation Before the 1970’s: –To protect from the abuses of monopoly power Since the 1970’s (especially since 1996): –To facilitate the development (and maintenance) of competition

More on changed role of regulation Before the 1970’s: –Emphasis on regulating price, earnings and service delivery by monopoly company Since the 1970’s (especially since 1996): –Emphasis on interconnection among all companies (asymmetric regulation)

Theories of Regulation Public Interest Interest Group/Coalition Building (Public Choice) Capture Life Cycle Equity-Stability Organizational

Purpose of regulation At least in theory: –To protect the public interest

Origins of public interest concept Just price doctrine of medieval times Trade guilds of the middle ages French royal charters Common callings

Bases for Regulation Basic laws of the land (Constitution) Case Law Legislation

Legal Bases for Regulation Federal –Article I, Section 8 of the Constitution Commerce clause –Article VI of the Constitution Constitution as supreme law of the land State –Tenth Amendment of the Constitution Police powers of the state

Limitations on Regulation Federal –Fifth Amendment Due process Takings clause State –Fourteenth Amendment

Case law “Property does become clothed with a public interest when used in a manner to make it of public consequence, and affect the community at large. When, therefore, one devotes his property to a use in which the public has an interest, he, in effect grants to the public an interest in that use, and must submit to be controlled by the public for the common good.” Munn v. Illinois (1877)

Cases Munn v. Illinois: monopoly German Alliance v. Lewis: necessity Nebbia v. New York: virtually any enterprise if legislators deem it necessary to protect the public

Common Carriage What is it? Examples?

Definition in the Comm Act of 1934 Common Carrier for Hire –Applies to messages transmitted by wire or radio –Controls transmission (carrier) –Provides nondiscriminatory service (common) –Provides services for hire (profit) –Does not apply to broadcasting

Obligations and Privileges Obligations –Charge reasonable and non-discriminatory rates –Provide adequate service –Accept all customers on the same terms without discrimination Privileges –Limitations on liability

Public Utilities What are they? –More than common carriage How are they created? Obligations? Rights?

Public utility categories Enterprises which supply, directly or indirectly, continuous or repeated services through more or less permanent physical connections between the plant of the supplier and the premises of the consumer –Traditionally electric, gas, water, telephone Public transportation agencies

Public utility characteristics Capital intensive Sell services rather than goods Have to engineer their systems to deal with peak demand Usually “natural monopolies”

Demand characteristics of a public utility Inelasticity of demand—both price and income

Elasticity of Demand Price elasticity of demand –If when price goes up, demand goes down, then demand is elastic –If when price goes up, demand stays the same, then demand is inelastic Income elasticity of demand –If when income goes down, expenditure level goes down, demand is elastic –If when income goes down, expenditure level stays the same or doesn’t decrease in proportion, demand is inelastic

Elasticity examples Price demand = elastic Price demand = inelastic Income demand = elastic Income demand = inelastic

What do inelasticities mean? The service is a necessity.

Definitions of a “natural monopoly” Supply based Demand based

Supply based definition Economies of scale/scope: –When a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms Economies of scale and/or scope over a relevant range of output

More supply based characteristics Significant fixed and non-liquid investment (often called sunk costs) Problems of unused capacity (engineered for peak demand)

Demand based characteristics Diversity of demand—instantaneous and uninterrupted services at peak and off-peak times

Regulation needed to control abuses of monopoly power Monopoly pricing –Output set at less than the most socially efficient levels of production –Prices higher than the most socially efficient level –Discriminatory pricing Service provision Service quality

Marginal revenue/Marginal cost

Example of Monopoly Pricing Assume that 12 people are willing to pay $6 for an item that costs $5 to produce at this quantity: –Revenue is $6 x 12 units = $72 –Cost is$5 x 12 units = $60 –Profit is$72 - $60 = $12 Assume that 8 people are willing to pay $8 for the item, that costs $6 to produce at this quantity: –Revenue is $8 x 8 units = $64 –Cost is $6 x 8 units = $48 –Profit is $64 - $48 = $16

Regulation to encourage competition Asymmetrical regulation –Not a level playing field—on purpose Control activities of dominant firm –Pricing Avoid cost subsidization Avoid predatory pricing –Interactions with competitors Require interconnection Require provision of essential facilities