Regulation

Natural Monopolies Breaking up a monopoly that isn’t natural is a good idea Breaking up a monopoly that isn’t natural is a good idea – Ex. Microsoft buying Apple Why? Why? The gains to the consumer outweigh the loss to the producer 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 A monopoly in which large producers have lower average total costs than small producers Should these be broken up? Should these be broken up? If they do, it would raise total costs 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 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 D ATC Quantity Price, cost Relevant output range Natural monopoly. Average total cost is falling over the relevant output range Natural monopolist’s break-even price

Natural Monopolies With all monopolies, even natural monopolies, a profit-maximizing monopolist acts in a way that causes inefficiency 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 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? How can better economic outcomes be established? Through public policy and public regulation Through public policy and public regulation

Public Ownership The good is supplied by the government or by a firm owned by the government 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 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 Disadvantage: less eager than private companies to keep costs down

Price Regulation Also known as industrial regulation Also known as industrial regulation Limits the price that a monopolist is charged 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 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 Regulators seek to establish rates that will cover production costs and create a “fair” return to the price

Natural Monopolies Rate Regulation Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY

Q D MR MC ATC P Price and Costs Monopoly Price MR = MC QmQm PmPm

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Fair-Return Price Normal Profit Only QfQf PfPf

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Socially-Optimum Price P = MC QrQr PrPr

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs MR = MC Fair-Return Price Socially-Optimum Price QmQm QfQf QrQr Dilemma of Regulation Which Price? PmPm PfPf PrPr

Costs and Inefficiency Unregulated firms have an incentive to reduce its costs at each level of output because it will increase its process 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 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 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 Problem with industrial regulation is that it perpetuates monopoly long after the conditions of natural monopoly have ended What creates this? What creates this? Technological change Technological change – Trucks verse railroads, cell phones verse land lines Commissions set up to regulate 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 Some industries seek regulation or want to maintain regulation in order to form/maintain a legal cartel Why? Why? It can guarantee a profit It can guarantee a profit How? How? Blocking entry Blocking entry Illegal? Illegal? Private cartels are, govern-sponsored cartel under regulation are not Private cartels are, govern-sponsored cartel under regulation are not

Deregulation & Social Regulation Deregulation has produced large net benefits for consumers and society Deregulation has produced large net benefits for consumers and society Specifically, airlines, railroads and trucking Specifically, airlines, railroads and trucking Also in long-distance telecommunications, cable television Also in long-distance telecommunications, cable television Deregulation of electricity has been a success with a few setbacks Deregulation of electricity has been a success with a few setbacks

Social Regulation Is not concerns with natural monopolies but with good and services produced, the impact of production on society and the physical qualities of the goods themselves Is not concerns with natural monopolies but with good and services produced, the impact of production on society and the physical qualities of the goods themselves Commission (Year Established) Jurisdiction Food and Drug Administration 1906 Safety and effectiveness of food, drugs, and cosmetics Equal Employment Opportunity Commission 1964 Hiring, promotion, and discharge of workers Occupational Safety and Health Administration 1971 Industrial health and safety Environmental Protection Agency 1972 Air, water, and noise pollution Consumer Product Safety Commission Safety of consumer products

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? What is the optimal level? Remember, it is recommended for any industry/firm to have it MB exceed its MC 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 the MB of social regulation exceeds MC, too little social regulation If MC exceed MD, too much! If MC exceed MD, too much!

So, is there a free lunch? Social regulation can produce higher prices, stile innovation, and reduce competition Social regulation can produce higher prices, stile innovation, and reduce competition But, less government intervention is not always better than more government 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 Breaking up a monopoly that isn’t natural is a good idea Why? Why? The gains to the ____________outweigh the loss to the ____________ 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 A monopoly in which large producers have lower average total costs than small producers Should these be broken up? Should these be broken up? If they do, it would raise ____________ If they do, it would raise ____________ Ex. Ex.

Increasing Returns to Scale Create Natural Monopoly D ATC Quantity Price, cost Relevant output range Natural monopoly. Average total cost is falling over the relevant output range Natural monopolist’s break-even price

Natural Monopolies With all monopolies, even natural monopolies, a profit-maximizing monopolist acts in a way that causes ____________ 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 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? How can better economic outcomes be established?

Public Ownership The good is supplied by the government or by a firm owned by the government 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 ____________ Advantage of this: a publicly owned natural monopoly can set ____________ based on the criterion of ____________ rather than profit ____________ Disadvantage: Disadvantage:

Price Regulation Also known as ____________ regulation Also known as ____________ regulation Limits the price that a monopolist is charged 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 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 Regulators seek to establish rates that will cover production costs and create a “____________” return to the price

Natural Monopolies: Rate Regulation 1.Socially Optimum Price ____________ ____________ 2.Fair-Return Price ____________ ____________ Dilemma of Regulation REGULATED MONOPOLY

Q D MR MC ATC P Price and Costs Monopoly Price ____________ QmQm PmPm

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Fair-Return Price Normal Profit Only QfQf PfPf

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Socially-Optimum Price ____________ QrQr PrPr

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs MR = MC Fair-Return Price Socially-Optimum Price QmQm QfQf QrQr Dilemma of Regulation Which Price? PmPm PfPf PrPr

Costs and Inefficiency Unregulated firms have an ____________ to reduce its costs at each level of output because it will increase its process 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 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 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 Problem with industrial regulation is that it perpetuates monopoly long after the conditions of natural monopoly have ended What creates this? What creates this? ____________ ____________ ____________ ____________ – Ex. ____________ set up to ____________ ____________ 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 Some industries seek regulation or want to maintain regulation in order to form/maintain a legal cartel Why? Why? ________________________ ________________________ How? How? ________________________ ________________________ Illegal? Illegal? Private cartels are, govern-sponsored cartel under regulation are not Private cartels are, govern-sponsored cartel under regulation are not

Deregulation & Social Regulation Deregulation has produced large net benefits for ____________ and ____________ Deregulation has produced large net benefits for ____________ and ____________ Specifically, ________________________ Specifically, ________________________ Also in long-distance telecommunications, cable television Also in long-distance telecommunications, cable television Deregulation of electricity has been a success with a few setbacks 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 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 Administration 1906 Safety and effectiveness of food, drugs, and cosmetics Equal Employment Opportunity Commission 1964 Hiring, promotion, and discharge of workers Occupational Safety and Health Administration 1971 Industrial health and safety Environmental Protection Agency 1972 Air, water, and noise pollution Consumer Product Safety Commission Safety of consumer products

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? What is the optimal level? Remember, it is recommended for any industry/firm to have it ______ exceed its ______ Remember, it is recommended for any industry/firm to have it ______ exceed its ______ If the ______ of social regulation exceeds ______, too little social regulation If the ______ of social regulation exceeds ______, too little social regulation If ______ exceed ______, too much! If ______ exceed ______, too much!

So, is there a free lunch? Social regulation can produce ______ prices, little ____________, and reduce ____________ Social regulation can produce ______ prices, little ____________, and reduce ____________ But, less government intervention is not always better than more government But, less government intervention is not always better than more government