Regulation Private rights versus public needs

Why Regulate? If competition cannot exist, or survive long, and an unregulated market will not produce competitive results If competition does exist, but because of imperfections in the market, competition does not produce competitive results If competitive results are unsatisfactory because of other policy considerations

Role of regulation Perform the balancing of interests that the market provides in a competitive marketplace –Interests of buyers versus sellers –Interests of subscribers versus stockholders

Legal Bases for Regulation Federal –Article I, Section 8 of the Constitution Commerce clause –Article VI of the Constitution Constitution as supreme law of the land –Federal regulation of intrastate commerce only to remove unjustly discriminatory inequalities or unreasonable preferences State –Tenth Amendment of the Constitution Police powers of the state

Limitations on Regulation Federal –Fifth Amendment Due process Takings clause –Article I, Section 10 No state laws to impair the obligation of contracts State –Fourteenth Amendment

Theories of Regulation Public Interest Interest Group/Coalition Building Capture Life Cycle Equity-Stability Organizational

Origins of public interest concept Just price doctrine of medieval times Trade guilds of the middle ages French royal charters Common callings

Case law “Property does become clothed with a public interest when used in a manner to make it of public consequence, and affect the community at large. When, therefore, one devotes his property to a use in which the public has an interest, he, in effect grants to the public an interest in that use, and must submit to be controlled by the public for the common good.” Munn v. Illinois (1877)

Common Carriage What is it? Examples?

Definition in the Comm Act Common Carrier for Hire –Applies to messages transmitted by wire or radio –Controls transmission (carrier) –Provides nondiscriminatory service (common) –Provides services for hire (profit) –Does not apply to broadcasting

Obligations and Privileges Obligations –Charge reasonable and non-discriminatory rates –Provide adequate service –Accept all customers on the same terms without discrimination Privileges –Limitations on liability

Public Utilities What are they? –More than common carriage –Provide “essential services” How are they created? Obligations? Rights?

Public utility categories Enterprises which supply, directly or indirectly, continuous or repeated services through more or less permanent physical connections between the plant of the supplier and the premises of the consumer –Traditionally electric, gas, water, telephone Public transportation agencies

Public utility characteristics Capital intensive Sell services rather than goods Have to engineer their systems to deal with peak demand “natural monopolies” –Note: While public utilities are natural monopolies, not all natural monopolies are public utilities

Potential Sources of Monopoly Key resource is owned by one firm Government gives franchise to only one firm The concept we are discussing here: –Cost of production makes a single producer more efficient (natural monopoly)

Definitions of a “public utility” (and to some extent, a natural monopoly) Supply based Demand based

Supply based definition Economies of scale/scope (natural monopoly): –When a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms Economies of scale and/or scope over a relevant range of output

More supply based characteristics (public utility) Significant fixed and non-liquid investment (often called sunk costs) Problems of unused capacity (engineered for peak demand) Technical limitations

Demand based characteristics (public utility) Diversity of demand—instantaneous and uninterrupted services at peak and off-peak times Position of the consumer—close connection between provider and premises restricting choice Inelasticity of demand—both price and income

Elasticity of Demand Price elasticity of demand –If when price goes up, demand goes down, then demand is elastic –If when price goes up, demand stays the same, then demand is inelastic Income elasticity of demand –If when income goes down, expenditure level goes down, demand is elastic –If when income goes down, expenditure level stays the same or doesn’t decrease in proportion, demand is inelastic

Elasticity examples Price demand = elastic Price demand = inelastic Income demand = elastic Income demand = inelastic

Regulation to control abuses of monopoly power Monopoly pricing –Output set at less than the most socially efficient levels of production –Prices higher than the most socially efficient level –Discriminatory pricing Service provision Service quality

Example of Monopoly Pricing Assume that 12 people are willing to pay $6 for an item that costs $5 to produce at this quantity: –Revenue is $6 x 12 units = $72 –Cost is$5 x 12 units = $60 –Profit is$72 - $60 = $12 Assume that 8 people are willing to pay $8 for the item, that costs $6 to produce at this quantity: –Revenue is $8 x 8 units = $64 –Cost is $6 x 8 units = $48 –Profit is $64 - $48 = $16

Regulation to encourage competition Asymmetrical regulation –Not a level playing field—on purpose Control activities of dominant firm –Pricing Avoid cost subsidization Avoid predatory pricing –Interactions with competitors Require interconnection Require provision of essential facilities