Micro economic theory shows how prices and product flows are used in unregulated markets.
Sometimes the market outcomes are not optimal and the government intervenes to improve them.
In this section we look at the regulation of natural monopolies, environmental protection, and farm output and prices.
The goal is to find out if government regulation can improve market outcomes.
You should know LO1 after reading this chapter.
The regulatory dilemma is posed by natural monopoly.
There are costs associated with regulation.
In 2001 the lights went out in California.
Offices went dark, air conditioners shut lated markets may produce the wrong mix of output, assembly lines stopped, and TV screens went able methods of production.
The governor blamed the power company.
Government intervention can also fail.
He charged the companies with raising prices and curtailing power supplies.
We will be able to contrast quickly in other states.
The theory of deregulation with reality was applied to some states.
Other states put deregulation plans on hold because of what happened in California.
A model for economic efficiency can be found in a perfectly competitive market.
The market mechanism can answer the basic economic questions of what to produce, how to produce it and who.
These conditions are rarely, if ever, fully attained.
The market mechanism that output, raise prices, stifle competition, and inhibit innovation may be restricted by these producers in wielding their power.
It's better to worry about industry struc ture or prevent abuse of market power.
Regulation seeks to change market outcomes directly by imposing specific limitations on price, output, or investment decisions.
The choice between structural and behavioral remedies is simplified when there is a natural monopoly.
Because of the scale economies, one firm can achieve monopoly and produce the products consumers want at the lowest possible price.
A single economies of scale over the cable company is more efficient than a bunch of cable firms.
Local telephone service and many utilities are the same.
A single company can deliver products at a lower cost than a bunch of smaller firms.
The cost advantage would be destroyed if the natural monopoly was dismantled.
Natural monopolies might enjoy economies of scale, but they might not pass those savings along to consumers.
The government might have to regulate the firm's behavior if the economies of scale don't do consumers any good.
The next page shows the unique characteristics of a natural monopoly.
A single large firm can underprice any smaller firm because unit costs keep falling.
All the market supply can be produced at the lowest cost.
Such a firm will come to dominate the industry in an unregulated market.
Natural monopolies emerge when the fixed costs of production are large.
To supply electricity, you first need to build a power source and then a distribution network.
Before anyone gets a ride, a lot of infrastructure needs to be built.
The natural monopoly ATC curve is affected by a combination of high fixed costs and low marginal costs.
The marginal cost is negligible when you supply another kilowatt of electricity.
The costs of carrying one more passenger on a train or subway are very low.
Even if marginal costs rise as production increases, they are still less than average total cost over the entire range of output.
The ATC curve does not rise into its normal U shape because marginal costs never exceed average costs.
As in conventional cost structures, there is no force to pull average total costs up.
The ATC curve is unique due to the combination of high fixed costs and low marginal costs.
The ATC curve starts out high and keeps declining as output increases.
The ATC curve is a hallmark of a natural monopoly.
There is a potential benefit to society from the declining costs of a natural monopoly.
The average cost would be higher with a competitive market structure.
Natural monopolists have the same motivation as other producers.
They have the power to achieve and maintain economic profits.
There is no guarantee that consumers will benefit from a natural monopoly.
Critics say that the monopolist keeps most of the benefits.
Consumers have complained about high prices, poor service, and a lack of programming choices from local cable monopolies.
The figure shows the behavior of a natural monopolist.
The natural monopolist will maximize profits by producing at a rate of output where marginal revenue is less than marginal cost.
Society doesn't like the natural monopolist's preferred outcome.
We end up consuming less of this product than we would if it were free.
ATC is driven down to its minimum in a competitive industry.
Average total costs would fall if output increased further.
Millions of Californians believed that this kind of "profiteering" was the root of their electricity problems.
Consumers demand government intervention when they see a free-swinging natural monopoly.
pervasive economies of scale can be overcome by the market alone.
The government could make different decisions.
We might consider price regulation.
The government can lower the price by regulating the firm.
In 1996 the California legislature set a maximum retail price for electricity.
There are a lot of choices when setting a regulated price.
It is possible to set the price at a level that is consistent with opportunity costs.
Monopolists cause a suboptimal allocation of resources by charging a price in excess of marginal cost.
The monopolist could improve market outcomes by setting the price equal to marginal cost.
MC is always less than ATC.
This was one of the many problems that happened in California.
Unable to charge a price high enough to cover their costs, some of the state's utility companies were forced into bankruptcy.
The natural monopoly needs a subsidy.
Subsidies are given to subway systems.
Increased use of expensive transportation systems is ensured by these subsidized fares.
Taxpayers always complain about the cost of subsidized pricing.
Taxpayers don't like to give them to private companies.
Despite the economic benefits of this regulatory strategy, political considerations preclude efficient (marginal cost) pricing.
We wouldn't achieve maximum production efficiency even if it were possible to impose marginal cost pricing.
The production efficiency is the lowest possible.
The market losses would need to be offset by a subsidy.
We could try profit regulation instead of price regulation.
If we don't subsidize a natural monopolist, we must allow it to charge a price high enough to cover all its costs, including a normal profit.
The result can be achieved by mandating a price.
There are two reasons profit regulation looks appealing.
The need to subsidize the monopolist is eliminated first.
It removes the need to develop demand and cost curves by allowing us to focus on profits only.
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In practice, profit regulation can turn out ugly.
bloated costs and dynamic inefficiency can be caused by profit regulation.
The firm has no incentive to limit costs if it is allowed a specific profit rate.
Higher costs imply higher profits.
A monopolist that charges 10 percent over unit costs may be better off with an average cost of $6.
60 cents of profit per unit is achieved by the higher costs.
The commission found that the company overcharged its customers by tens of millions of dollars over a four-year period so that the company could pad its profits illegally.
The FCC said that a transfer of profits to a subsid fine would be the largest it has ever imposed.
The commission was applying rules retroactively, denied England.
William C. Ferguson said there was no intent to overcharge.
Excerpted with permission.
Incentives for a regulated firm to inflate its costs are created by profit regulation.
It is possible to pay high prices for products purchased from unregulated subsidiaries.
Cost increases are attractive to the firm and its employees if they represent improvements in wages, fringe benefits, and the work environment.
Cost efficiency is just as welcome as the plague.
A firm can inflate its costs by paying above-market prices for products purchased from an unregulated subsidiary.
The "Baby Bell" that provided phone service in New York and New England in the 1970s was accused by the FCC of using the same strategy to pad its profits.
Some level of service may be ensured by regulation.
Regulators may choose to regulate output because of the difficulties in regulating prices and profits.
It is easy to enforce output regulation.
Problems can be caused by minimum-service regulation.
Reducing quality control can be accomplished by deferring plant and equipment maintenance.
Quality may decline if quantity is regulated.
Consumers have to accept whatever quality the monopolist offers since there is no direct competition.
Consumers complain a lot about the services of local cable monopolies.
Minimum service regulation is not a panacea for the regulatory dilemma.
Any regulatory rule can cause goal conflicts.
The call for public regulation of natural monopolies is based on the fact that the profit motive doesn't generate optimal outcomes in a monopoly environment.
Natural monopolists will charge too much and produce too little if unregulated.
There is no regulatory remedy for market failures.
The only way regulators can force efficient prices or least-cost production is by offering a subsidy.
Cost-inflating responses are likely to be caused by profit regulation.
Quality deterioration is an incentive for output regulation.
Regulatory problems result no matter which way we turn.
There isn't much hope for transforming market failure into regulated outcomes.
Regulators must choose a strategy that balances competing objectives.
Regulation may lead to price, cost, or production intervention that is inferior to the unregulated market.
It isn't enough to improve outcomes in a market.
Industry regulation involves a number of options and trade-offs.
These trade-offs need to be assessed by someone.
A regulatory administration has access to a lot of information.
The demand and cost curves depicted in Figures 27.2 and 27.3 must have some clue as to the actual shape and position of the demand and cost curves.
When decisions about the prices, output, or costs of an industry are being made, crude illustrations won't suffice.
The regulatory lawyers, accountants, and economists could be employed at The Weidenbaum Center on the other side of the country.
Almost 200,000 people are employed in regula Policy at Washington University tory agencies of the federal government.
The major executive departments and smaller agencies have regulatory responsibilities.
More than 100,000 people are employed by state and local regulatory agencies.
Our labor resources are limited.
We are forgoing their use in the production of desired goods and services by using them to regulate private industry.
This is an economic cost.
Resource use in the public sector is the focus of the administrative costs of regulation.
To change their production behavior, to file reports with the regulatory authorities, and to educate themselves about the regulations are all things regulated industries must do.
Regulations on trucking can increase production costs.
In 2003 the U.S. Department of Transportation reduced the amount of time allowed for interstate trucking.
The rule requires freight companies to use more trucks and labor.
The cost of achieving that safety gain is not unimportant.
The potential costs of changes in output have to be considered.
The mix of output should always be improved by regulation.
If this occurs, the loss of utility associated with an inferior mix of output imposes a further cost on society.
Over time, efficiency costs may increase significantly.
Consumer tastes change, demand and marginal revenue curves change, costs change, and new technologies emerge.
Optimal regulations may become obsolete if not.
Tens of thousands of people are employed in the Food Safety and Inspection Service.
The Transportation Security Adm. could be producing other goods and services.
Customs and Border Security and other costs must be compared.
The FAA and Federal Motor Carriers Safety Adm. are part of the Federal Aviation Adm.
The Occupational Safety and Health Adm. is part of the Mine Safety and Health Adm.
The Environmental Protection Agency, Forest and Rangeland Research, and the Fish and Wildlife Service are included.
The SEC, Federal Trade Commission, and Patent and Trademark Office are included.
The Federal Reserve System, Federal Deposit Insurance Corporation, and Comptroller of the Currency are included.
The losses may be the most important.
The costs of regulation pale in comparison to the distortions of the economy.
The public never sees the factories that weren't built, the new products that didn't appear, or the entrepreneurial idea that drowned in a cumbersome regulatory process.
October 19, 1992
410 deaths a year attributed to are expected to reduce highway fatalities, but also contribute fatigue-related truck crashes, and that's 410 very good reasons to the biggest increase in trucking rates in two decades.
The time that truck drivers have to rest from the Transportation Department's Federal Motor Carrier has been increased.
The agency expects that the new rules will save up to 75 lives a year and prevent as many as 1,326 fatigue hours from being worked.
The new rules could cost trucking companies more than a billion dollars a year.
The effects could be far-reaching because trucks haul so much commerce.
Copyright 2003 by truck transportation says higher trucking rates could lead to a DOW JONES & COMPANY, Inc.
Regulations designed to improve outcomes tend to impose higher costs.
Balance benefits and costs is a challenge.
Dynamic efficiency losses are a drag on economic growth, limiting outward shifts of the production possibilities curve while perpetuating an increasingly undesired mix of output.
The "no free lunch" maxim is a reminder of the economic costs of regulation.
The regulatory process could be used for other purposes.
The cost of achieving perfect outcomes might outweigh the benefits.
The economic cost of regulation must be balanced with the anticipated improvements in market outcomes.
The marginal benefit of regulation must be greater than the marginal cost.
Even if it would improve short-run market Price Regulation outcomes, additional regulation isn't desirable.
The first concern was about the inefficiencies that regulation imposes.
Over time, the inefficiencies had accumulated and rendered regulated industries less productive.
Advances in technology destroyed the basis for natural monopoly in some industries.
The impact of these forces is shown in a brief review.
The federal government's first regulatory target was the railroad industry.
When Congress created the interstate commerce commission, there were no airports or interstate highways to compete with the railroads.
The purpose of theICC was to assure a fair profit to the railroad owners.
The rates and routes for the railroads were established by the ICC.
Railroad regulation became obsolete with the advent of alternative modes of transportation.
Railroads were unable to adapt their prices or services to meet changing consumer demands because of regulated cargo, routes and prices.
They had little incentive to invest in new technologies.
Railroad traffic and profits declined while other transportation industries flourished.
The Railroad Revitalization and Regulatory Reform Act was enacted in 1976.
Reducing the scope of government regulation was its main goal.
Railroads were given more freedom to adapt their prices and service after the Staggers Rail Act of 1980.
Railroad companies were able to increase their share of freight traffic.
Fruits and vegetable shipments increased over 30 percent in the first year of deregulation.
Similar changes were caused by deregulation of coal traffic and piggyback traffic.
The railroads cut operating costs and offered lower rates.
The cost of moving freight by rail went down between 1986 and 1993.
Some rates have not fallen.
The rail industry concentration has increased as a result of deregulation.
During 1998 and 1999, the top four railroads moved nearly 90 percent of all rail freight.
These firms had monopoly positions on certain routes.
Shippers in captive markets were paying higher rates.