Transcript (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 downwardsloping 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 profitmaximizing 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.
Natural Monopoly
Price (dollars per unit)
Average total cost
Demand
Unregulated p
pA
ATC = p
C
pC
pB
MCA
0
Marginal cost
B
A
qA
MR
qC
Quantity (units per period)
qD
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.
Price Regulation
Price (dollars per unit)
Average total cost
Demand
Unregulated p
pA
ATC = p
pD
C
pC
pB
MCA
0
Marginal cost
B*
B
A
qA
MR
qC
Quantity (units per period)
qD qB
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.
Price (dollars per unit)
Minimum Service Regulation
Demand
Unregulated p, q
pA
D
pD
pC
pB
0
Average
total cost
Marginal cost
qA
MR
qD
qC
Quantity (units per period)
qB
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
600
500
400
300
Deregulation
200
100
0
1970 71
72
73
74
75
76
77
78
79
80
81
82
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 longdistance 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 wouldbe 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 reregulation.
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
+9.5%
+7.1%
+5.1%
+0.9%
Regulated
Prices
1976 – 86
Deregulated
Prices
1986 – 92
Reregulated
Prices
1992 – 95
Deregulated
Prices
1996–2002
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