Alternatives to Regulation of Natural Monopoly

1. Alternatives to Regulation of Natural Monopoly Franchise Bidding & Public Ownership

2. Franchise Bidding • Competing providers “bid” prices for service in a given area/time period • With “enough” competition, P = AC of lowest cost provider without regulation • Lack of competition => inflated AC • DWL relative to “competitive” P = AC • “Winner” earns excess profit (economic π > 0) • Problems • Long-term contracts leave city as regulator • “winner” susceptible to “hold-up” • Incentive to degrade quality over time • Political activity may influence bids/outcome

3. Franchise Bidding • Empirical Studies • Bidding has not worked well in practice • Cable TV • Virtually unregulated monopoly • Early Electric & Natural Gas Industries • Cities “held-up” providers over time • Prompted current state-level r-o-r regulation

4. Public Ownership • Services by Government-owned entities • Consider divergent incentives for managers • Private • Labor market – do well move up • Market for corporate control – threat of takeover • Stock ownership makes incentives consistent • Public • Maximize political support • More discretion to act in own interest • Constraints • Labor Market • Political scandal – may lose job as scapegoat

5. Public Ownership • Implications of Incentive Differences • Private (Regulated) • May over-invest: A-J Effect • Price to recover all (perhaps inflated) costs • Price discriminate to maximize profits • Public Ownership • Over-provide quality, raise costs • Lower prices – reduce DWL, increase SW • Less discrimination – may reduce SW

6. Public Ownership • Empirical Research • Very mixed • Private • more efficient, but charge higher prices • Public • Inefficient, but lower prices, less discrimination • Recent Electricity Studies • Private more efficient in generation, vertical integration • Public more efficient at small scale, distribution only • Suggests political/economic “niche” for both Private and Public Ownership