New regulatory policies entail the creation of market competition in such industries or alternatively the creation of competition for the market. Expenses wl where w is the wage rate and l is the number of workers i b is the capital cost or rate base, e. However, there is an efficient quantity of output produced so that the market is efficient with no deadweight loss. Joskow department of economics, massachusetts institute of technology contents 1. Another type of inefficiency occurs if the monopoly incurs costs to maintain its monopoly position. Darryl biggar accc annual regulatory conference 24 july 2008. At its core, economic regulation focuses on the pursuit of economic efficiency typically defined in terms of price, service quality and upholding competitive outcomes wherever possible. Conflict can occur between public services and commercial procedures e. Fundamental economic theory for business pdf download. This included, but was not limited to, the regulation of monopolies. Stigler 1971 advocated an economic theory of how the regulation of business comes to be. Discuss with reference to any markets and industries of your choice a pure monopoly exists when there is a single seller in a market the firm is the industry and the demand curve for the firms products is also the market demand curve.
Economic regulation, however, is fundamentally a permissionbased system. This new edition of the leading text on business and government. In the transportation sector, for example, many industries have market structures that inherently limit entry and can lead to concentration or monopoly e. Y2 28 competition policy monopoly regulation youtube. With unknown costs, both instruments are equivalent. The emphasis of the report is on wholesale electricity markets, including enabling regulation and the motivations that lead to wholesale electricity market implementation. Consequences, regulation and prevention summary of chapter 8 in microeconomic policy. Mar 20, 20 11 when a natural monopoly is regulated using a marginal cost pricing rule, what can you say about the firms profit and the markets efficiency. Pdf once models of monopoly behaviour have been outlined and explored in this chapter, the discussion considers government regulation of monopolies.
Ramsey, a contribution to the theory of taxation, the economic journal 37, no. Lecture notes government regulation of industry economics. The united states can uniquely boast more than 100 years of experience in regulation in the public interest through a social compact that balances and protects the interests of investors and ratepayers both. For example, in addition to economies of scale he notes.
Monopoly, quality, and regulation ucsb department of economics. Governments may also reserve the right to regulate certain activities for economic, social or other purposes. Economics of regulation and antitrust, fourth edition. A significant amount of the material in this chapter has been drawn from my lectures on the regulation of natural monopolies in the graduate course that i have taught at mit for many years. The design of regulatory mechanisms to control monopoly market power when the firm. Social regulation comprises regulation in the area of the. Examples are price control, rules against advertising and minimum quality standards. Basso nicol as figueroay jorge v asquez z preliminary and incomplete draft please do not quote may 2010 abstract in this paper we compare two mechanisms to regulate a monopoly. Pdf this chapter provides a comprehensive overview of the theoretical and empirical literature on the regulation of natural monopolies. Legal monopoly definition, rationale and practical example. The case for regulated monopoly in the electric grid smart. Proproducer tendencies are disciplined by consumer groups meaning that price is less than the monopoly level. For example, monopolies have the market power to set. This pdf is a selection from an outofprint volume from the national.
The case for regulated monopoly in the electric grid. Fundamental economic theory for business pdf download author. A natural monopoly poses a difficult challenge for competition policy, because the structure of costs and demand seems to make competition unlikely or costly. Monopoly a monopoly is a firm who is the sole seller of. Rey, 2008, notes on the economics of termination charges.
Competition and monopoly in internal energy markets the paper aims to present the main principles of implementing market competition and monopoly regulation in internal energy markets of a country and particularly in the electric power sector. In economics, the idea of monopolies is important in the study of management structures, which directly concerns normative aspects of economic competition, and provides the basis for topics such as industrial organization and economics of regulation. It was demsetz 1968 who argued that formal regulation, as described above, is uncalledfor where government can allow rivalrous competitors to bid for the exclusive right to supply a good or service over the given franchise. This alternative explanation is based on protecting the investment in sunk complementary assets on the part of users and consumers of the monopoly service. While strong natural monopolies exhibit decreasing average costs, the weak natural monopoly firm exhibits increasing. In simple terms, a natural monopoly is a market that can be most efficiently supplied by a sole seller, e. A natural monopoly arises when average costs are declining over the range of production that satisfies market. Conduct regulation is used for regulating behavior in the market. The natural monopoly modela natural monopoly exists in an industry where a single firm can produce output such as to supply the market at a lower per unitcost than can two or more firms. Competition and strategic investments it is not only monopolies that require regulation, oligopoly markets do tooalong with his coauthors, tirole has provided a number of important contributions to theories of competition law. On the other hand, in the absence of any competition the monopoly holder will be tempted to exploit his natural monopoly power in order to maximize its profits. Economic regulation is mainly exercised on natural monopolies and market structures with limited or excessive competition.
American economists began analyzing natural monopolies and the economic perfor. Behavioral and market equilibrium considerations 1238 2. Posner a firm that is the only seller of a product or service having no close substitutes is said to enjoy a monopoly1 monopoly is an important concept to this article but even more important is the related but somewhat less. There are some lost gains from trade, from buyers whose willingness to pay is above marginal cost, but below the monopoly price. There are four basic types of market structures in traditional economic analysis. This chapter will deal with only one of these the economic regulation of prices, output, entry and exit. This pdf is a selection from an outofprint volume from the national bureau of economic research volume title. The theories developed for monopoly regulation have been oriented towards utility.
Economic regulation may also include overall performance monitoring, as is the case in europe. These resources could instead be used for productive. On the one hand a natural monopoly implies that efficiency in production would be better served if a single firm supplies the entire market. Joskow1 1 department of economics, massachusetts institute of technology, cambridge, ma, usa. However, the whole impetus for considering a regulated monopoly in place of a competitive market is that the vertically integrated monopoly can successfully take advantages of economies of scope and play the orchestra more efficiently than otherwise. What economic regulation is not economic regulation must also be distinguished from other forms of regulation. Another example of a natural monopolist is when there is an exceptionally high development cost, as was the case with iscor in the 1920s. Monopoly regulation under asymmetric information wiley online. Economic theory of regulation tendency for regulation to be designed to benefit relatively small groups with strong preferences relative to big groups with weak preferences.
Monopoly a monopoly is a firm who is the sole seller of its. Monopoly conditions for air navigation service provision lead states to apply economic regulation, in the form of price controls or institutional restrictions on ansps, to ensure that an ansps monopoly position is not abused in setting user charges. Over the 100 years or more of state and federal regulation of public utilities in the united states there has been debate over what constitutes a reasonable price for. Price capping limiting price increases regulation of mergers breaking up monopolies investigations into cartels and. Transport is also subject toregulation of product quality, most notably safety. When technical conditions make a monopoly the natural outcome of competitive market forces, there are only three alternatives that seem available. I propose an alternative explanation as to how natural monopoly regulation promotes economic welfare.
Nov 27, 2019 the government may wish to regulate monopolies to protect the interests of consumers. A monopoly is a specific type of economic market structure. Service quality in regulated monopolies by catherine. Regulation is generally defined as legislation imposed by a government on individuals and private sector firms in order to regulate and modify economic behaviors. We start in section 2 with his seminal work on the public regulation of a natural monopoly, most of which re. Workstream a regulatory mechanisms for dealing with uncertainty a final report prepared for ofgem march 2003 frontier economics limited 150 holborn london ec1n 2ns tel. Secondly, we discuss the costs, benefits, methods, and outcomes of economic regulation from a theoretical standpoint, and then examine the actual u.
A monopoly exists when a specific person or enterprise is the only supplier of a particular good. Review of economic regulation of liquid fuels and related. The government may wish to regulate monopolies to protect the interests of consumers. Technological progress technological developments have been the drive behind the transformation of certain natural monopoly markets to more competitive outcomes. During the 1980s, industrial and labour market policies in most oecd countries. The economic theory of natural monopoly kenneth button regulator uses information on the firms observed costs and output in one time period. Crucial video covering monopoly regulation through competition policy. Waterson 1988 notes, a governmentowned or regulated monopoly may better ensure that all customers have access to these services at reasonable prices. This book is currently in print and may only be viewed by individuals for evaluation purposes.
A significant amount of the material in this chapter has been drawn from my lectures on the regulation of natural monopolies in the graduate course that i have taught at mit for many. Second, regulation may be used to set criteria for access and to place requirements on participants through licencing. Regulation since the efficient quantity is where the demand curve intersects the marginal cost curve, what. First, where there is entrenched market power most obviously where there are natural monopolies economic regulation may be adopted to constrain the exercise of this power. The new tools of economic theory and deep insights into the production conditions of a number of regulated industries gave tirole an exceptionally good foundation on which to renew and deepen the analysis of regulation and market power. However, using a mathematical model of the market for a directly networked good and indeed, what is the smart grid but a network of users sharing information in order to increase the quality of service, it is possible to show that under certain reasonable assumptions a regulated monopoly performs closer to the social optimum than competition. The economic case against monopoly is not yet fully proven. The telephone industry, electricity and water supply are often cited as examples of natural monopolies. Entry regulation and auctionuntil 1968, the inevitability of regulation of natural monopoly was broadly accepted. Monopoly a monopoly is a firm who is the sole seller of its product, and where there are no close. Competitive electricity market regulation in the united. Expenses wl where w is the wage rate and l is the number of.
The economic theory of natural monopoly is exceedingly brief and, we shall see. A natural monopoly poses a difficult challenge for competition policy, because the structure of costs and demand makes competition unlikely or costly. Stiglers starting point was the observation that, as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit. Regulation policies concerning natural monopolies in. A natural monopoly arises when average costs are declining over the range of production that satisfies market demand. Besides for price changes of equipment, con struction and labor, the major question for capitalintensive firms is. As a result, monopolies are characterized by a lack of competition within the market producing a good or service. Optimal price regulation for natural and legal monopolies core.
Once models of monopoly behaviour have been outlined and explored in this chapter, the discussion considers government regulation of monopolies, government action to prevent the formation of. Competition and monopoly in internal energy markets. For example, monopolies have the market power to set prices higher than in competitive markets. Economics of regulation and antitrust, fourth edition the. Although the firm moves, over time, to ramsey prices, this proposal raises a host of strategic issues for the firm. A natural monopoly exists in an industry where a single firm can produce output such as to supply the market at a lower per unitcost than can two or more firms. A substantially revised and updated new edition of the leading text on business and government, with new material reflecting recent theoretical and methodological advances. Regulation policies concerning natural monopolies in developing. Optimal regulation, by kenneth train, the mit press, 1991. The concept of natural monopoly presents a challenging public policy dilemma. Using a marginal cost pricing rule, the monopoly is incurring an economic loss.
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