INTRODUCTION

The chapter answers the following questions:



When is government regulation necessary?
What form should that regulation take?
When is it appropriate to deregulate an industry?
(DE)REGULATION OF BUSINESS
Chapter 12
2
ANTITRUST VS. REGULATION

Under ideal conditions, the market mechanism
provides optimal outcomes:





BEHAVIORAL FOCUS
 Government
intervention may be
appropriate in industries where market
power prevails.
 Antitrust laws give two options for
government intervention:
 The structure of an industry.
 The behavior of an industry.
All producers must be perfect competitors.
People must have full information about tastes, costs,
and prices.
All costs and benefits must be reflected in market
prices.
Pervasive economies of scale must be absent.
These ideal conditions are rarely, if ever,
attained, leading to market failure.
Market Failure - An imperfection in the
market mechanism that prevents optimal
outcomes.
3
BEHAVIORAL FOCUS
4
NATURAL MONOPOLY
Antitrust is government intervention to alter
market structure or prevent abuse of market
power.
 Government regulation focuses almost
exclusively on behavior.





A natural monopoly is desirable because it can
achieve economies of scale.
Regulation is government intervention to alter
the behavior of firms, for example, in pricing,
output, or advertising.
5
Natural monopoly – An industry in which one firm
can achieve economies of scale over the entire range
of market supply.
Of course, it is likely that consumers will not
benefit from the resulting cost savings.
6
DECLINING ATC
UNREGULATED BEHAVIOR
The distinctive characteristic of a natural
monopoly is its downward-sloping average total
cost (ATC) curve.
 The marginal cost (MC) curve lies below the ATC
curve at all rates of output.
 The economies of scale offered by a natural
monopoly imply that no other market structure
can supply the good as cheaply.
Although the structure of a natural monopoly
may be beneficial, its behavior may leave
something to be desired.
 The unregulated pricing of a natural monopolist
violates the competitive principle of marginal
cost pricing.


7
UNREGULATED BEHAVIOR
8
NATURAL MONOPOLY
 Because
P > MC, consumers are not
getting accurate information about the
opportunity cost of products sold in
monopoly markets.
 The natural monopolist’s profitmaximizing output also fails to minimize
average total cost.

Price (dollars per unit)
Average total cost
REGULATORY OPTIONS
Unregulated p
pA
ATC = p
C
pC
pB
MCA
0
The economic profits potentially earned by
monopolist may violate our visions of equity.
Marginal cost
B
A
qA
MR
qC
MC = p
qD
Quantity (units per period)
9

Demand
10
PRICE REGULATION
There are a number of regulatory options to deal
with natural monopoly.

11
The government could regulate the monopolist’s
price.
12
PRICE EFFICIENCY
SUBSIDY
The government could force the monopolist to set
its price equal to marginal cost.
 But, in a natural monopoly, MC is always less
than ATC.
Hence, marginal cost pricing by a natural
monopolist implies a loss on every unit of output
produced.
 In order to provide efficient pricing, a subsidy
must be provided to the natural monopoly.


13
PRODUCTION EFFICIENCY
14
PRICE REGULATION
In a natural monopoly, production efficiency is
achieved at capacity production, where ATC is at
a minimum.
 No regulated price can induce the monopolist to
achieve minimum average cost.

Price (dollars per unit)

Average total cost
A subsidy would be required to offset market
losses.
Demand
ATC = p
pD
C
pC
pB
MCA
0
Marginal cost
B*
B
A
qA
MR
qC
MC = p
qD qB
Quantity (units per period)
15
PROFIT REGULATION
Unregulated p
pA
16
BLOATED COSTS
The government can regulate the natural
monopoly so that it makes a normal profit.
 The government would set the price where P =
ATC.
If a firm is permitted a specific profit rate (or rate
of return), it has no incentive to limit costs.
 Profit regulation creates incentives for a
regulated firm to inflate (“pad”) its costs.


17
18
OUTPUT REGULATION
MINIMUM SERVICE REGULATION
The government can regulate the natural
monopoly’s output.
 Regulation of the quantity produced may induce
a decline in quality.
 Goal conflicts are inescapable, and any
regulatory rule may induce undesired producer
responses.
Price (dollars per unit)

Demand
Unregulated p, q
pA
D
pD
pC
pB
0
Average
total cost
Marginal cost
qA
IMPERFECT ANSWERS
IMPERFECT ANSWERS
A
 The
realistic regulatory goal is to choose a
strategy that balances competing
objectives.
 That is, to improve market outcomes, not
to perfect them.
MR
qD
qC
qB
Quantity (units per period)
19
20
choice isn’t between imperfect markets
and flawless government intervention.

The choice is between imperfect markets and
imperfect intervention.
 In
some cases, government failure may be
worse than market failure.
21
22
THE COSTS OF REGULATION
ADMINISTRATIVE COSTS
 There

Someone must sit down and assess these
regulation tradeoffs.
 The costs of these lawyers, accountants, and
engineers represent a real cost to society.
are costs associated with regulation:
Administrative costs.
 Compliance costs.
 Efficiency costs.

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24
COMPLIANCE COSTS

EFFICIENCY COSTS
There is a cost for regulated firms to educate
themselves, change their production behavior
and to file reports with the regulatory
authorities.

Inefficient regulation (bad decisions, incomplete
information, and faulty implementation) has a
cost associated with it.
25
BALANCING BENEFITS AND COSTS

26
DEREGULATION IN PRACTICE
Regulatory intervention must balance the
anticipated improvements in market outcomes
against the economic cost of regulation.

The push to deregulate is prompted by two
concerns:


The inefficiencies that regulation imposes.
Advancing technology destroyed the basis for natural
monopoly.
 Please
read and understand the case
studies on in the book (p. 262- 272).
27
DEREGULATE EVERYTHING?
28
DEREGULATE EVERYTHING?
In many industries, deregulation has resulted in
more competition, lower prices, and improved
service.
 Changing consumer demand, new technologies,
and substitute goods had made existing
regulations obsolete.
One shouldn’t conclude that regulatory
intervention never made sense just because the
regulations later became obsolete.
 The transmission networks for local telephone
service and electricity delivery are still natural
monopolies.
 Although the government can force owners to
permit greater access, an unregulated network
owner could still extract monopoly profits
through excessive prices.


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30
(DE)REGULATION OF BUSINESS
End of Chapter 12