(De)Regulation Of Business
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Transcript of (De)Regulation Of Business
(De)Regulation Of Business
Chapter 12
Antitrust vs. Regulation Under ideal conditions, the market
mechanism provides optimal outcomes: 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.
Antitrust vs. Regulation These ideal conditions are rarely, if
ever, attained, leading to market failure.
– Market failure - An imperfection in the market mechanism that prevents optimal outcomes.
Behavioral Focus Antitrust laws give two options for
government intervention: The structure of an industry. The behavior of an industry.
Behavioral Focus Antitrust is government intervention
to alter market structure or prevent abuse of market power.
• Regulation is government intervention to alter the behavior of firms, for example, in pricing, output, or advertising.
Natural Monopoly A natural monopoly is desirable because it
can achieve economies of scale. However, it is likely that consumers will not
benefit from the resulting cost savings.
Natural monopoly – An industry in which one firm can achieve economies of scale over the entire range of market supply.
Declining ATC 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.
Declining ATC The economies of scale offered by a
natural monopoly imply that no other market structure can supply the good as cheaply.
– Economies of scale - Reductions in minimum average costs that come about through increases in the size (scale) of plant and equipment.
Unregulated Behavior The unregulated pricing of a natural
monopolist violates the competitive principle of marginal cost pricing. Marginal cost pricing – The offer
(supply) of goods at prices equal to their marginal cost.
Unregulated Behavior Because P > MC, consumers are not
getting accurate information about the opportunity cost of products sold in monopoly markets.
– Opportunity cost – The most desired goods or services that are forgone in order to obtain something else.
Unregulated Behavior The natural monopolist’s profit-
maximizing output also fails to minimize average total cost.
Unregulated Behavior The economic profits potentially
earned by monopolist may violate our visions of equity.
– Economic profit – The difference between total revenues and total economic costs.
Pric
e (d
olla
rs p
er u
nit)
Quantity (units per period)
Natural Monopoly
Average total cost
Demand
Marginal cost
MCA
qA qC qD0 MR
C
BA
pB
pC
pAUnregulated p
ATC = p
MC = p
Regulatory Options There are a number of regulatory
options to deal with natural monopoly: Price regulation. Profit regulation. Output regulation.
Price Regulation The government could regulate the
monopolist’s price.
Price Efficiency 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.
Subsidy Marginal cost pricing by a natural
monopolist implies a loss on every unit of output produced.
A subsidy must be provided to the natural monopoly in order to provide efficient pricing,.
Production Efficiency 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 ATC.
A subsidy would be required to offset market losses.
Pric
e (d
olla
rs p
er u
nit)
Quantity (units per period)
Price Regulation
Average total cost
Demand
B*Marginal cost
MCA
qA qC qBqD0 MR
C
BA
pB
pC
pD
pAUnregulated p
ATC = p
MC = p
Profit Regulation The government can regulate the
natural monopoly so that it makes a normal profit.
The government would set the price where P = ATC.
Bloated Costs 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.
Output Regulation The government can regulate the
natural monopoly’s output. Regulation of the quantity produced
may induce a decline in quality.
Pric
e (d
olla
rs p
er u
nit)
0Quantity (units per period)
Minimum Service Regulation
Average total cost
Demand
D
Marginal cost
pA
pD
pCpB
qA qD qC qBMR
Unregulated p, q
Imperfect Answers A realistic goal is to choose a strategy
that balances competing objectives. The choice isn’t between imperfect
markets and flawless government intervention.
• The choice is between imperfect markets and imperfect intervention.
Imperfect Answers In some cases, government failure
may be worse than market failure.– Government failure – Government
intervention that fails to improve economic outcomes.
The Costs of Regulation There are costs associated with
regulation: Administrative costs. Compliance costs. Efficiency costs.
Administrative Costs Someone must sit down and assess
these regulation tradeoffs. The costs of these lawyers,
accountants, and engineers represent a real cost to society.
Compliance Costs There is a cost for regulated firms to
educate themselves, change their production behavior and to file reports with the regulatory authorities.
Efficiency Costs Inefficient regulation (bad decisions,
incomplete information, and faulty implementation) has a cost associated with it.
Balancing Benefits and Costs Regulatory intervention must balance
the anticipated improvements in market outcomes against the economic cost of regulation.
Deregulation in Practice The push to deregulate is prompted
by two concerns: The inefficiencies that regulation
imposes. Advancing technology destroyed the
basis for natural monopoly.
Railroads The Interstate Commerce Commission
(ICC) was created in 1887 to limit monopolistic exploitation of the railroad situation while assuring a “fair” profit to railroad owners.
Railroads With the advent of buses, trucks,
subways, airplanes and pipelines as alternative modes of transportation, railroad regulation became increasingly obsolete.
Railroads The Railroad Revitalization and
Regulatory Reform Act of 1976 and the Staggers Rail Act of 1980, granted railroads much greater freedom to adapt their prices and service to market demands.
Railroads Railroad companies used that
flexibility to increase their share of total freight traffic.
The railroads prospered by reconfiguring routes and services, cutting operating costs, and offering lower rates.
Railroads Between 1986 and 1993, the average
cost of moving freight by rail dropped by 69 percent.
Railroads After a series of mergers and
acquisitions the top four railroads moved nearly 90 percent of all rail freight in 1998-99.
Some firms held monopoly positions on specific routes and charged 20-30 percent more than in non-monopoly routes..
Railroad Traffic: Before and After Deregulation
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1970 75 76 7774737271 78 79 80 81 82
Deregulation
Telephone Service With high fixed costs and very low
marginal costs, the telephone had long been an example of natural monopoly.
Technology outpaced regulation and greatly reduced the cost for new firms to provide long-distance service.
Long Distance Telephone Service In 1982, the courts put an end to
AT&T’s monopoly. Since then, over 800 firms have
entered the industry, and long-distance telephone rates have dropped sharply.
Rates have fallen and service has improved.
Local Telephone Service As competition in long distance
services increased, the monopoly nature of local rates became painfully apparent.
Local rates kept increasing after 1983 while long-distance rates were tumbling.
Local Telephone Service New technologies permitted
“wireless” companies to offer local service if they could gain access to the monopoly networks.
Local Telephone Service Congress passed the
Telecommunications Act of 1996 requiring the Baby Bells to grant rivals access to their transmission networks.
Local Telephone Service The Baby Bells have been accused of
charging excessive access fees, imposing overly complex access codes, requiring unnecessary capital equipment, and raising other entry barriers.
Local Telephone Service The FCC and state regulatory
agencies lowered entry barriers in 2001-02 which allowed rivals to increase market share to 12 percent.
Airlines The Civil Aeronautics Board (CAB) was
created in 1938 to regulate airline routes and fares.
Its primary objective was to ensure a viable system of air transportation for both large and small communities.
Airlines The focus of the CAB was on profit
regulation.
• A secondary objective was to ensure air service to smaller, less-traveled communities.
Airlines Short hauls entail higher average
costs and, therefore, higher fares.
• By fixing airfares, the CAB eliminated price competition between established carriers.
Airlines Regulators used cross-subsidization to
keep local rates low.– Cross-subsidization – Use of high prices and
profits on one product to subsidize low prices on another product.
No Entry The CAB was extremely effective in
restricting entry into the industry. From 1938 until 1977 the CAB never
awarded a major route to a new entrant.
No Price Competition The CAB eliminated price competition
between established carriers. The CAB fixed airfares on all routes.
Bloated Costs Despite the high regulated fares,
established carriers were unable to reap much profit.
Costs rose as carriers used frequent flights and product differentiation to attract passengers.
Bloated Costs Profit regulation came to be regarded
as a failure.– Airlines weren’t making substantial profits.– Consumers weren’t being offered very many
price-service combinations.
New Entrants The Airline Deregulation Act of 1978
eliminated the regulatory barrier to entry. Barriers to entry – Obstacles that make
it difficult or impossible for would-be producers to enter a particular market.
New Entrants Between 1978 and 1985, the number
of airline companies increased substantially.
Price competition reduced average fares as much as 40 percent below regulated levels.
Increasing Concentration Unable to match lower fares and
increased service, scores of airline companies exited the industry in the period 1985-95.
The combined market share of the three largest carriers nearly doubled between 1985 and 1993.
Increasing Concentration Some companies have gained near
monopoly power in specific “hub” airports.
Ticket prices are 45 to 85 percent higher on monopolized routes than on routes where at least two airlines compete.
Entry Barriers Major carriers exploit their hub
dominance, and keep rivals out through their ownership of landing slots.
Entry Barriers Defenders of deregulation argue that
most airline markets are competitive. They argue the airline industry is a
contestable market. Contestable market – An imperfectly
competitive industry subject to potential entry if prices or profits increase.
Cable TV The cable TV industry has gone
through both deregulation and re-regulation.
Deregulation The Cable Communications Policy Act
of 1984 deregulated the industry.
Congress believed that broadcast TV and related technologies offered sufficient competition to ensure consumers fair prices and quality service.
Reregulation After a period of rapid price growth,
the industry was re-regulated in 1992. Cable operators were required to
reduce prices by nearly 17 percent in 1993-94..
They claimed that the lost revenue will keep them from desired upgrades.
Deregulation The Telecommunications Turns Act of
1996 mandated that rate regulation be phased out and ended completely by March 1999.
Cable prices soared again.
Annual Increase in Price of Basic Cable Service
+5.1%
RegulatedPrices
1976 – 86
DeregulatedPrices
1986 – 92
+9.5%
ReregulatedPrices
1992 – 95
+0.9%
DeregulatedPrices
1996–2002
+7.1%
Electricity The electric utility industry is the
latest target for deregulation.
The industry had long been regarded as a natural monopoly.
Bloated Costs, High Prices Critics complained that local utility
monopolies allowed costs to rise and had little incentive to apply new technologies.
Demise of Power Plant Monopolies There is no longer a need to rely on a
regional utility monopoly.
New high-voltage transmission lines can carry power thousands of miles with negligible power loss.
Local Distribution Monopolies Although technology destroyed the basis
for monopoly in power production, local natural monopoly in power distribution remain.
California’s Mistakes California legislation stripped local
utilities of their production capacity.
California utilities became totally dependent on third-party power producers.
California’s Mistakes A ceiling was placed on retail
electricity prices, but not on wholesale prices.
• When wholesale prices rose sharply in 2000, many California utilities declared bankruptcy because retail prices were fixed too low.
Better Strategies Other states and countries have
demonstrated how deregulation can generate much better results.
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.
Deregulate Everything? One shouldn’t conclude that
regulatory intervention never made sense just because the regulations later became obsolete.
(De)Regulation Of Business
End of Chapter 12