3. Insights on competitive structures_II Flashcards
Pg 53 (BIE studocu notes)
Natural Monopoly
Sometimes a monopoly is better than everything: Natural monopoly
.
Natural Monopoly –> Subadditivity of cost function
[a]n industry in which multi-firm production is more costly than production by a single firm (Baumol, 1977, p. 810)
The assumption is the subadditivity of the cost function, which means an industry where multi- firms production is more costly than production by a single firm.
.
Extra:
Equal quantity in both cases
case 1: costs in case of more than one firm
Case 2: costs of one firm low
.
Note: Scale economies are a sufficient but not a necessary condition to prove subadditivity
.
Formula:
TC(Total cost) = F (fixed cost) + cq (variable cost)
AC avg cost curve = F/q + c (This curve is always decreasing in terms of quantity) = dAC/dq = -F/q^2 = 0
MC marginal cost = c
2 Conditions of Natural Monopoly
Productive efficiency: monopoly leads to a higher level of productive efficiency.
.
MES: minimum efficient scale
We can introduce the concept of minimum efficient scale (MES): it is the minimum cost of production if one firm produces all the quantity. The TC area of one firm is less than the sum of the other firms TC areas.
(Take a look at notes on the computer)
.
The closer we are to the MES, the more likely is to be in a natural monopoly because a second firm has to cover the cost gap.
The natural monopoly is a crucial economic concept behind the public service utilities. These utilities are natural gas, electricity, water, telecommunications, and railroads. These businesses deliver an essential good or service through a wide network infrastructure.
There are different phases to deliver these services: (Natural monopolies in network industries) (public utilities)
Production/ generation/ TLC network services
Transportation/transmition/TLC backbone
Distribution/TLC local loop
Sale
In order to understand, if we are in a situation of natural monopoly we have to find the MES:
In order to understand, if we are in a situation of natural monopoly we have to find the MES:
.
MES= dAC/dq=0
.
Once found the MES, we have to look at the demand curve. If the demand curve intersect the AC curve far from the MES, it is not a natural monopoly.
Demand is the reason why policy makers decided to open competition in some phases of the utility services.
For example, considering the transportation of natural gas, the size of the market is close or slightly higher than the MES. The total cost suffered by one firm is lower than the cost split among more companies.
.
The example in the slides.
.
In this industry, there are strong economies of scale related to:
Strong scale economies: why?
General reasons
A. Great amount of indivisible resources
Resources that should be present even for small scale operations
Examples: Central delivery points, Rapid interventions team, Regulatory Office, …
.
B. Specialization of workforce
Less specialized employees, lower productivity
Geographically specialized network planners and operators
Specific reasons
.
C. Pipelines: “volumetric returns to scale”
As the diameter of the pipe doubles, its volume increases by a factor of 4, while its surface area only increases by a factor of 2
.
D. Administrative costs
Administrative/bargaining costs for acquiring the right to transit bargained with (local) governments which are relatively insensitive to the volume of gas transported
Natural monopoly: What is the most cost-efficient market configuration?
Natural Monopoly
Size of the market close or slightly higher than MES
Question: What is the most cost-efficient market configuration?
Example: slide 7, insights on comp struc 2
Public utilities
Natural monopoly was and still is the crucial economic concept behind public service utilities and many network industries.
.
Natural Gas, Electricity, Telecommunications (Water, Railroads, among others): all businesses that delivers an essential good or service through a wide network infrastructure.
Natural Monopoly in Network industries
Gas, Electricity, Telecommunications
- Production/Generation/TLC Network service
- Transportation/Transmission/TLC backbone
- Distribution/TLC local loop
- Sale
.
Liberalization processes in Network industries
- Production/Generation/TLC Network service
- Sale
.
Why?
2 main reasons (mutually reinforcing):
1. demand-side explanation
2. supply side explanation
.
Public intervention: Regulation of a Natural monopoly
Productive efficiency–> Single firm
Single firm (if market non contestable) –> Monopoly outcome
Loss in allocative efficiency –> Can the public actor re-balance the loss in allocative efficiency while keeping productive efficiency? –> Regulation
.
From a social welfare point of view, the productive efficiency forces the policy makers to rely on a single firm. The monopoly outcome leads to a loss of allocative efficiency. The policy makers can re-balance this situation using regulation.
Economic Regulation: There are two types of regulations:
- Ex-post regulation: ANTITRUST (later in the course): it is a collection of laws which regulates the conduct and organization of business corporations to promote fair competition for the benefit of consumers.
It’s about fair competition principles set in-advance.
.
2 areas of great importance:
-Anticompetitive practices (e.g. cartels)
-Abuse of dominant position
.
–> Policy intervenes to punish anticompetitive behavior
.
. - Ex-ante regulation: (Usually referred to this when talking about regulation) specific REGULATORY COMMISSIONs that right from the beginning set invasive and pervasive “rules of the game” (e.g. including prices of final or intermediate services/products).
Before firms enter market, they have a set of rules to comply with. If you want to participate in the market, you have to comply.
From the discussion in class
Extra:
For utilities, firm is not private (profit goal) but state-owned with the objective of maximizing the social welfare. These monopolies are possible with an implicit regulation. Nevertheless, the privatization process of state-owned companies changes their goals introducing the need of an ex- ante regulation stated by a commission (in Italy, AGCOM and AEEGSI).
.
The regulations impose to the monopolist a price that maximizes the social welfare being more similar to costs. If pM=MC, the firm can recover only variable costs losing the fixed costs. From a social point of view, this is the best solution. Often the regulation imposes pM=AC: therefore, firm does not incur in a loss without having an extra-profitability. From a social point of view, this is the second best solution.
There are two elements reinforcing the need of regulation: 2 important reasons reinforce the need to regulate network industries rather then only natural monopoly: 1. Non-redeployable investments (Sunk costs); 2. Inelastic demand
Non-redeployable investments (sunk costs) –> REGULATION NECESSITY <– Inelastic demand
.
There are two elements reinforcing the need of regulation:
1. Sunk Costs: Non-redeployable investments
Extra :
- Long-life plants
- Second-hand markets are imperfect
Implications:
- under-investment
- no competition
.
2. Inelastic demand.
There are two elements reinforcing the need of regulation: Sunk Costs, Inelastic demand
There are two elements reinforcing the need of regulation:
.
Extra
There are two elements reinforcing the need of regulation: Sunk costs, Inelastic demand
Inelastic demand: utilities are necessary for= the population without having perfect substitutes. The monopolist optimum price is:
(p-MC)/p
If price very high, monopoly will face inelastic demand.
.
Extra:
There are two reasons of competition in the production and sale phases:
.
- Demand-side explanation: we are asking more and more these services causing a movement of demand (shift to the right).
Inelastic demand
Gas, electricity, telecom: very much “necessity goods” with no or imperfect substitutes
Monopolist optimum price : (p-MC)/p = 1/|e|
