R EGULATION MBA Managerial Economics Lecturer: Jack Wu

R EGULATION natural monopoly potentially competitive market asymmetric information externalities public goods

N ATURAL M ONOPOLY Average cost minimized with single supplier large scale/scope economies relative to market demand

M ARGINAL C OST P RICING Require provider set price equal to marginal cost supply quantity demanded demand marginal cost

A VERAGE C OST P RICING Require provider set price equal to average cost supply quantity demanded demand marginal cost average cost

R ATE OF R ETURN R EGULATION maximum rate of return on rate base disallowed profit returned to users

P OTENTIALLY C OMPETITIVE M ARKET Economies of scale/scope are small relative to market demand technology market demand

MATH EXAMPLE Suppose that the demand for electric power is P=10-q. P represents price in thousand dollars and q represents quantity in megawatt-hours. All generating plants have a capacity of 10 megawatt-hours. Generation involves a fixed cost of $50,000 and a constant marginal cost of $1000 per megawatt- hour. Now, suppose that the demand grows to P= q. How many plants would be needed to meet the quantity demanded?

S TRUCTURAL R EGULATION Bar franchise holder from vertically related markets prevent monopoly from extending market power

M ORAL H AZARD IN M EDICINE supply inflated demand true demand quantity (million hours a mth) price ($/hour) a b

R ESOLVING I NFORMATION A SYMMETRY mandatory disclosure regulation of conduct structural regulation

E MISSIONS marginal cost to society quantity (tons/year) marg. cost/benefit ($/ton) marginal benefit to society

E MISSIONS F EE user fee quantity (tons/year) marg. cost/benefit ($/ton) marginal benefit to society

A CCIDENTS marginal cost to driver quantity (units of care) marg. cost/benefit s marginal benefit to society

P UBLIC G OODS legal framework enables excludability copyright patent trade-off incentive for knowledge creation economically efficient usage of information

P UBLIC P ROVISION For some public goods, practically difficult to enforce exclusion national defense clean air fireworks

C ONGESTIBLE F ACILITIES social marginal cost varies with usage resolve through user fee = social marginal cost time usage

DISCUSSION QUESTION The demand for electric power in Sol Province is p = q, where p and q represent the price in thousands of dollars and quantity in Megawatt hours, respectively. Suppose that an electricity plant generates power at a constant marginal cost of $1000 per megawatt hour up to a capacity of 10 megawatt hours. Sol Province requires the plant to implement marginal-cost pricing.

DISCUSSION QUESTION Illustrate the price and quantity with marginal cost pricing. Suppose that demand grows to P=20-0.1q. At a price of $1000 per megawatt hour, what is the minimum number of plants needed to produce the quantity demanded?