Transcript Regulation
Incentives and Organization and Regulation Managerial Economics Jack Wu Outline • • • • organizational architecture moral hazard ownership vertical integration Organizational Architecture • distribution of ownership • incentive schemes • monitoring systems Moral Hazard • asymmetric information about action • conflict of interest Moral Hazard in Employment employer’s marginal benefit worker’s marginal benefit Quantity (units of effort) worker’s marginal cost efficient effort Moral Hazard in Banking • premium for deposit insurance is not experience-rated ▫ riskier the investment, the greater the expected benefit for the bank owners and the higher the expected loss for the Central Bank conflict of interest • Central Bank cannot easily monitor actions of the bank Resolving Moral Hazard • incentive scheme ▫ conditional payment ▫ quota • monitoring system ▫ incentives must be based on observables Incentive vs Risk Efficient scheme balances • benefits of more effort • costs of risk bearing ▫ degree of risk ▫ risk aversion Relative Performance • employment -- promote the best worker • sports -- gold, silver, bronze • examination – grade on a curve Multiple Responsibilities • strong incentive ▫ more effort on that dimension ▫ less effort on other dimensions Non-Profit Organizations • school’s objective ▫ maximize profit ▫ maximize education of students • other examples – hospital, museum • non-profit organization to tone down profit incentive Holdup • Holdup = opportunistic behavior = action intended to exploit another party’s dependence • unlike moral hazard, holdup can arise even if information is symmetric Resolving Holdup • avoid specific investments • write more detailed contracts • vertical integration (redistribute ownership) Complete Contract • specifies actions and payments in every contingency • degree to which a contract should be complete ▫ potential benefits and costs at stake ▫ extent of possible contingencies Ownership Residual rights • control -- rights that have not been contracted away • income -- remaining after payment of all other claims Vertical Integration Combination of assets for two successive stages of production under a common ownership • upstream: away from final consumer ▫ Dominion Resources acquired Consolidated Natural Gas, 1999 • downstream: closer to final consumer ▫ Phillips Petroleum acquired Tosco, 2001 Vertical Integration: Impact Owner • gets rights to residual control and residual income • reduces potential for holdup Regulation Regulation • • • • • natural monopoly potentially competitive market asymmetric information externalities public goods Natural Monopoly Average cost minimized with single supplier • large scale/scope economies • relative to market demand Marginal Cost Pricing Require provider • set price equal to marginal cost • supply quantity demanded demand marginal cost Average Cost Pricing Require provider • set price equal to average cost • supply quantity demanded demand average cost marginal cost Rate of Return Regulation • maximum rate of return on rate base • disallowed profit returned to users Potentially Competitive Market Economies of scale/scope are small relative to market demand • technology • market demand Structural Regulation Bar franchise holder from vertically related markets ▫ prevent monopoly from extending market power Moral Hazard in Medicine price ($/hour) supply a b inflated demand true demand quantity (million hours a mth) Resolving Information Asymmetry • mandatory disclosure • regulation of conduct • structural regulation marg. cost/benefit ($/ton) Emissions marginal cost to society 35 marginal benefit to society 8000 quantity (tons/year) marg. cost/benefit ($/ton) Emissions Fee user fee 35 marginal benefit to society 8000 quantity (tons/year) Accidents marg. cost/benefit marginal cost to driver s marginal benefit to society quantity (units of care) Public Goods • legal framework enables excludability ▫ copyright ▫ patent • trade-off ▫ incentive for knowledge creation ▫ economically efficient usage of information Public Provision For some public goods, practically difficult to enforce exclusion • national defense • clean air • fireworks Congestible Facilities • social marginal cost varies with usage • resolve through user fee = social marginal cost ▫ time ▫ usage