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Regulation

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  1. Regulation

  2. 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

  3. 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

  4. Increasing Returns to Scale Create Natural Monopoly Price, cost Natural monopoly. Average total cost is falling over the relevant output range Natural monopolist’s break-even price A T C D Quantity Relevant output range

  5. 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

  6. 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

  7. Price Regulation • Also known as industrial regulation • Limits the price that a monopolist is charged

  8. 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

  9. REGULATED MONOPOLY Natural Monopolies • Rate Regulation • Socially Optimum Price • P = MC • Fair-Return Price • P = ATC • Dilemma of Regulation

  10. REGULATED MONOPOLY Monopoly Price MR = MC P Pm Price and Costs ATC MC D MR Q Qm

  11. REGULATED MONOPOLY P Fair-Return Price Normal Profit Only Price and Costs ATC Pf MC D MR Q Qf

  12. REGULATED MONOPOLY P Socially-Optimum Price P = MC Price and Costs ATC MC Pr D MR Q Qr

  13. REGULATED MONOPOLY Dilemma of Regulation Which Price? P MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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

  19. Social Regulation vs. Industrial Regulation • Applies to more firms, applied “across the board” to all industries and affects more producers • Intrudes into the day-to-day production process • Ex. EPA • Social regulation expanded when industrial regulation waned

  20. 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!

  21. 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

  22. Regulation Notes

  23. Natural Monopolies • Breaking up a monopoly that isn’t natural is a good idea • Why? • The gains to the ____________outweigh the loss to the ____________

  24. 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.

  25. Increasing Returns to Scale Create Natural Monopoly Price, cost Natural monopoly. Average total cost is falling over the relevant output range Natural monopolist’s break-even price A T C D Quantity Relevant output range

  26. 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?

  27. 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:

  28. Price Regulation • Also known as ____________ regulation • Limits the price that a monopolist is charged

  29. 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

  30. REGULATED MONOPOLY • Natural Monopolies: • Rate Regulation • Socially Optimum Price • ____________ • Fair-Return Price • ____________ • Dilemma of Regulation

  31. REGULATED MONOPOLY Monopoly Price ____________ P Pm Price and Costs ATC MC D MR Q Qm

  32. REGULATED MONOPOLY P Fair-Return Price Normal Profit Only Price and Costs ATC Pf MC D MR Q Qf

  33. REGULATED MONOPOLY P Socially-Optimum Price ____________ Price and Costs ATC MC Pr D MR Q Qr

  34. REGULATED MONOPOLY Dilemma of Regulation Which Price? P MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr

  35. 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

  36. 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

  37. 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

  38. 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

  39. Social Regulation • Is not concerns with natural monopolies but with ____________ and ____________ produced, the impact of production on ____________ and the physical qualities of the ____________ themselves

  40. Social Regulation

  41. Social Regulation vs. Industrial Regulation • Applies to more firms, applied “across the board” to all industries and affects more producers • Intrudes into the day-to-day production process • Ex. ______________________ • Social regulation expanded when industrial regulation waned

  42. 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!

  43. 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