Theory of Natural Monopoly and Its Control

1
Theory of Natural Monopoly and Its Control

• I. What is natural monopoly?
• II. The pricing problem rate levels
• A. P MC B. P ATC
• Next topic The economics of multiple prices
• Note This weeks lectures will be extremely
  theoretical. The political and administrative
  side are well covered by Greer, chapter 14. We
  need to know BOTH views.

2
Theory of Natural Monopoly and its Control

• I. What is natural monopoly?
• A. Long-run average cost that decreases
• as the output rate increases.
• B. Temporary v. permanent
• C. Subadditivity
• 1. Economies of scale
• 2. Economies of scope
• 3. Economies of vertical integration
• D. The sustainability problem

3
Theory of Natural Monopoly

• II. The pricing problem rate levels
• A. P MC
• 1. Implications for efficiency
• 2. What to do with the loss?
• a. Is subsidy warranted?
• b. Incentive problem
• c. Should nonusers (taxpayers) pay?

4
Natural Monopoly II. Rate level

• B. TR - TC 0 Price ATC
• 1. Relation to the standard regulatory model
• 2. Welfare loss
• 3. Incentive problems, again
• C. The general regulatory framework
• 1 Profit limitation, which implies
• 2. Revenue adequacy, which implies
• 3. Cost recovery gt TR VC sK.
• C. Nonlinear pricing
• 1. Relation of quantity and expenditure
• 2. Two-part tariff
• 3. Declining-block tariff

5
The Economics of Multiple Prices

• Prologue Economics and Politics of Regulation.
• I. Price discrimination, revisited.
• A. Price discrimination without regulation.
• 1. Example AIDS drugs for southern Africa
• 2. Example discounted air fares.
• 3. Competitive concessions and
• the Robinson-Patman Act.
• 4. Moral discrimination v. restriction

6
Economics of Multiple Prices

• I. B. But is it discrimination? Cost element.
• C. Third degree discrimination
• 1. Requirements
• a. Pricing power
• b. Separate markets
• c. Different elasticities
• 2. Result MR1 MR2 MC

7
Economics of Multiple Prices

• I. Price discrimination, revisited
• D. Prices and elasticity
• 1. Under profit maximization
• 2. Under Ramsey pricing
• E. Some regulatory vocabulary
• 1. Cost of service vs. value of service
• 2. FDC vs. marginal cost
• 3. Value-of-service pricing

8
Economics of Multiple Prices

• I. Price discrimination, revisited
• F. Output-related discrimination
• G. When regulation requires discrimination.
• 1. Cross-subsidization of favored users.
• 2. Uniform prices when costs arent equal
• 3. A way to pay those fixed costs?

9
Economics of Multiple Prices

• II. Cross-subsidization
• A. Strict definition
• B. Cross-subsidization in the unregulated
  context
• 1. Pricing of related products.
• 2. A weapon of predation?

10
Economics of Multiple Prices

• II. Cross-subsidization
• C. Why regulation may require it
• 1. Fairness
• 2 Entitlement
• 3. Relation to political power
• D. The efficiency problem
• E. ALL cross-subsidization is price
  discrimination, but .....

11
Economics of Multiple Prices

• III. Peak-load pricing
• A. The basic peak-load problem
• B. System load and marginal cost.
• C. Who pays for peak capacity?
• D. Is marginal-cost pricing feasible?
• IV. Discrimination vs. peak pricing--its
  sometimes hard to tell the difference.