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.

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

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

• 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

chargedCommission

(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

Natural MonopoliesRate RegulationSocially Optimum Price

P = MCFair-Return Price

P = ATCDilemma of Regulation

REGULATED MONOPOLY

REGULATED MONOPOLY

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Monopoly PriceMR = MC

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REGULATED MONOPOLY

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MCATC

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Fair-Return PriceNormal Profit Only

Qf

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REGULATED MONOPOLY

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MCATC

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Socially-OptimumPriceP = MC

Qr

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REGULATED MONOPOLY

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MR

MCATC

P

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MR = MC

Fair-Return Price

Socially-OptimumPrice

Qm Qf Qr

Dilemma of RegulationWhich Price?

Pm

Pf

Pr

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

• 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?

• 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

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 ____________

• 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

chargedCommission

(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

Natural Monopolies:Rate Regulation1. Socially Optimum Price

• ____________ 2. Fair-Return Price

• ____________ Dilemma of Regulation

REGULATED MONOPOLY

REGULATED MONOPOLY

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MR

MCATC

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Pri

ce a

nd

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Monopoly Price____________

Qm

Pm

REGULATED MONOPOLY

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D

MR

MCATC

P

Pri

ce a

nd

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Fair-Return PriceNormal Profit Only

Qf

Pf

REGULATED MONOPOLY

Q

D

MR

MCATC

P

Pri

ce a

nd

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Socially-OptimumPrice____________

Qr

Pr

REGULATED MONOPOLY

Q

D

MR

MCATC

P

Pri

ce a

nd

Co

sts

MR = MC

Fair-Return Price

Socially-OptimumPrice

Qm Qf Qr

Dilemma of RegulationWhich Price?

Pm

Pf

Pr

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 RegulationCommission

(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?

• 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