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1、Lecture 6: The Natural Monopoly ProblemEconomics of RegulationP13428 Economics of Regulation6. The Natural Monopoly ProblemReading:Baldwin & Cave Ch. 15 (short, simple introduction)Viscusi, Vernon & Harrington Ch. 11. (core reading)Church & Ware Ch. 24.1.2, 25 (extensions & models)So far:Section A o

2、f the course (4 lectures) examined contemporary competition policy towards:2. Collusion and Horizontal Agreements 3. Predation and Monopolisation4&5. Horizontal & Vertical MergersIntroduced rationale for government intervention in markets on grounds on allocative and productive efficiency.Lecture 6:

3、 The Natural Monopoly ProblemEconomics of RegulationSo far:Section A of the course (4 lectures) examined contemporary competition policy towards:2. Collusion and Horizontal Agreements 3. Predation and Monopolisation4&5. Horizontal & Vertical MergersIntroduced rationale for government intervention in

4、 markets on grounds on allocative and productive efficiency.Main role of competition policy in promoting competition: collusion, predation and petitive issues in mergers.However competition might not be feasible/desirable if natural monopolies exist.Lecture 6: The Natural Monopoly ProblemEconomics o

5、f RegulationFrom now on:Section B (5 lectures) of the course will study the so-called Natural Monopoly Problem6. The Natural Monopoly Problem7. Solutions I: Regulation8. Solutions II: Franchise Bidding9. Solutions III: Nationalisation10. The Regulatory Problem Under Asymmetric Information This Week:

6、What is a natural monopoly, how do they come about?Theoretical problems arising from natural monopolies. Preview possible solutions.Lecture 6: The Natural Monopoly ProblemEconomics of RegulationReview Questions:A production process presents economies of scale whenAverage variable costs are decreasin

7、gAverage total costs are decreasingMarginal costs are decreasingAverage fixed costs are decreasingA production unit works at its efficient scale whenMarginal costs are at the minimumAverage fixed costs are at the minimumAverage Variable costs are at the minimumAverage total costs are at the minimumL

8、ecture 6: The Natural Monopoly ProblemEconomics of RegulationCompetition policy is advocated against market power.But what if monopoly provision makes economic sense?Large economies of size/scope/densityLarge start-up costsInefficient to have more than one supplierLecture 6: The Natural Monopoly Pro

9、blemEconomics of RegulationCompetition policy is advocated against market power.But what if monopoly provision makes economic sense?Large economies of size/scope/densityLarge start-up costsInefficient to have more than one supplierLecture 6: The Natural Monopoly ProblemEconomics of RegulationDo we a

10、llow one firm to be the monopolist in such industries and gain economies of size even though PMC?e.g.Water, Electricity, Gas, Railways, munications?Or do we break-up firms so there is competition even though smaller firms will be inefficient?e.g. Two water companies supply water to the same town?Nat

11、ural Monopoly DefinedIn simple terms:A market which can be most efficiently supplied by a sole seller.Lecture 6: The Natural Monopoly ProblemEconomics of RegulationWhy?Principally, due to economies of size.Large sunk (fixed) costs, low variable costs.E.g. where network required to distribute good /

12、service.Applies to most utilities e.g. electricity, water, gas.And many services e.g. railways, s, postal services.Standard Costs vs. Natural Monopoly CostsMCATCAVCAFCQCQCMCAFCATCAVCLecture 6: The Natural Monopoly ProblemEconomics of RegulationTypical Firm:economies and diseconomiesNatural Monopoly:

13、economies over total range of QThe Natural Monopoly Problem I Monopoly provision would result in LARGE deadweight losses:MCATCD=ARMRPM=ARMQMACMMonopolists ProfitDeadweight Loss = 1 + 2 - ( + ) Lecture 6: The Natural Monopoly ProblemEconomics of Regulation12The Natural Monopoly Problem II But competi

14、tion would be worse (costs are sub-additive):MCATCDD=ARD PDQDMRQMMonopoly output(last slide)Duopoly outputHypothetically, turn monopoly into duopoly. Firms share market, i.e. individual demand = monopoly demand.More realistically. this is Bertrand competition with no entry vvh Ch. 11 appendixLecture

15、 6: The Natural Monopoly ProblemEconomics of RegulationThe Natural Monopoly Problem III The ideal price in allocative terms (MC=AR) results in a loss.MCATCD=ARMRPM=ARMQMACMMonopolists Profit Maximising ProfitPAE=ARAEACAEQAELoss arising from allocatively efficient output.(Allocative improvement also

16、productive improvement as lowering unit costs).Lecture 6: The Natural Monopoly ProblemEconomics of RegulationNatural Monopoly Definition ExpandedWe can now be more specific in defining the natural monopoly problem:The market can be most efficiently supplied by one sellerbecause competition is undesi

17、rable due to economies of sizebut private monopoly provision still creates a large deadweight losshowever the ideal price on allocative grounds results in the firm making a loss. Next: Example, Theoretical Extension, Solutions.Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExample: Na

18、tural Monopoly CostsSalvanes & Tjotta (1998) in Church & Ware Ch. 24.1.2 on restructuring of the Norwegian electricity market (expect economies of size).Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExample: Natural Monopoly CostsSalvanes & Tjotta (1998) in Church & Ware Ch. 24.1.2 o

19、n restructuring of the Norwegian electricity market (expect economies of size).Pre-1988 235 local electricity distributors across Norway.Hold individual franchises: could not be taken-over.Vary in size between 20,000i.e. range of sizes of outputCan we estimate cost savings from amalgamating smaller

20、firms into larger ones? Would unit costs fall (economies) or rise (diseconomies)?Assume firms have similar outputs (access to network, distribution) and similar production function (3 factors):Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExample: Natural Monopoly CostsEstimate cost

21、savings from monopoly of the services vs provision by two smaller firms:Smallest firms make biggest cost savings. but largest firms would make some savings.Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExample: Natural Monopoly CostsResults suggest cost savings to both small and larg

22、e firms, with benefits to small firms exceeding those of benefits to large firms, i.e. Unit CostCN. Access Contracts5,00010,00020,000+C1C2C38.5% fall in costs5.2% fall in costsSuggests cost curves look like natural monopoly costs.Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtensio

23、n: The domain of natural monopolySo far we have assumedOne ProductPermanent Natural MonopolyMore realistic formulation might be Natural Monopolyi) over certain range of output e.g. limited economies of sizeii) over certain period of time e.g. technological changeiii) with more than one good i.e. mul

24、tiproduct monopolistNow consider i). For types ii) and iii) see Church & Ware Ch. 25Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natural monopolyNatural Monopoly Versus Natural DuopolyFirm cost function:Lecture 6: The Natural Monopoly ProblemEconomics of Reg

25、ulationExtension: The domain of natural monopolyNatural Monopoly Versus Natural DuopolyFirm cost function:Marginal cost:Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natural monopolyNatural Monopoly Versus Natural DuopolyFirm cost function:Marginal cost:Avera

26、ge cost:Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natural monopolyNatural Monopoly Versus Natural DuopolyFirm cost function:Marginal cost:Average cost:MC(q)=AC(q) Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natur

27、al monopolyNatural Monopoly Versus Natural DuopolyFirm cost function:Marginal cost:Average cost:MC(q)=AC(q) so eff scale (min cost):Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natural monopolyWould a monopoly or duopoly minimise costs? Minimum cost of produ

28、cingq units with two firms is:Lecture 6: The Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natural monopolyWould a monopoly or duopoly minimise costs? Minimum cost of producingq units with two firms is:So industry is a natural monopolyfor levels of output where:Lecture 6: T

29、he Natural Monopoly ProblemEconomics of RegulationExtension: The domain of natural monopolyWould a monopoly or duopoly minimise costs? Minimum cost of producingq units with two firms is:So industry is a natural monopolyfor levels of output where: Which is true if:Lecture 6: The Natural Monopoly Prob

30、lemEconomics of RegulationExtension: The domain of natural monopolyGraphically:D1D2D3qmesAC22qmesqNMAC1CQNatural Monopoly up to qNM even though costs rise between qmes and qNM as output shared between duopoly firmssee Church & Ware Ch. 24.1.2D1: Nat. MonopolyD2: Nat. MonopolyD3: Nat. DuopolyLecture

31、6: The Natural Monopoly ProblemEconomics of Regulationp*Back to the central problem:Has to be a monopoly market. What is the most feasible option?MCATCD=ARMRPM=ARMQMMonopoly Output causes deadweight lossPAE=ARAEQAEIdeal Allocatively Efficient Output causes negative profit.Lecture 6: The Natural Monopoly ProblemEconomics of RegulationSecond-Best Pricing:Has to be a monopoly market. What is