Two pillars of priceentry regulation:

1
Two pillars of price-entry regulation

• Natural monopoly theory

• Takings law

2
Natural Monopoly Theory

• Competition doesnt work in some industries
• They tend to be capital-intensive (railroads,
  utilities)
• This creates barriers to entry
• Also price cutting (high fixed costs, low
  variable costs)

3
In price-cutting markets, only the strong survive

• Deep pockets can come from being big, or from
  selling in uncompetitive markets, as well as in
  competitive ones (cross-subsidization)
• Cut your prices in competitive markets until the
  competition folds up
• Then youve got the monopoly, and can charge what
  the traffic will bear

4
The solution to natural monopoly price and entry
regulation

• Control entry into markets to promote as much
  competition as possible (but not to allow
  destructive competition)

• Regulate price and quality of service (e.g.,
  cutting off electricity or heat for non-payment
  of bills)

5
But where do you set rates?

• Minnesota Rate Caseif the regulated cant earn a
  fair rate of return on invested capital, its a
  taking (5th Amendment no-no)
• Cost-of-service ratemaking
• How much capital have they invested? (Prudency)
• What rate of return are they getting from
  existing rates?
• How would proposed rates affect that rate of
  return?
• What is the going rate of return on invested
  capital?

6
Lessons learned by the 1970s from 100 years of
regulation

• Natural monopoly generally isnt
• Price-entry regulation stifles innovation, keeps
  prices high
• There are many ways to keep competition from
  being destructive (including antitrust
  enforcement)
• Lets de-regulate!

7
And a few whoopsies . . .

• Continuing airline bankruptcies
• The Savings and Load bailouts
• Monopolization/government takeover of rail
  transportation
• Enron sticking it to California

8
Where we are in 2004 Price-entry regulation is
dysfunctional, but we cant let it go completely