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Price Regulation of Natural Monopolies. Average total cost. “ Natural” Monopoly. Price/unit. Industry characterized by declining ATC. 0. Output/hr 产出 / 小时. Recall relationship between MC and ATC. MC. ATC. Price/unit. $3.50. $3.00. $2.50. $2.00. $1.50. $1.00. - PowerPoint PPT Presentation
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Price Regulation of Natural Monopolies
“Natural” Monopoly
Average total cost
Output/hr 产出 / 小时
Price/unit
0
Industry characterized by declining ATC
MC
ATC
Recall relationship between MC and ATC
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
0 2 4 6 8 10 12 Output/hr
MC and AC intersect at ATC minimum
Price/unit
The Problem of Setting Regulated Prices for a Natural Monopoly
Output/hr
Price/unit
0
MC
AC
Problem: Competitive-based pricing (P=MC) does not allow adequate cost recovery (< AC).
Demand
Qc
Pc
Setting Regulated Prices for a Natural Monopoly
Output/hr
Price/unit
0
MC
Demand
ACPR
Solution 1:PR = AC(Q) Quantity sold = QR
QR
Qc
Pc
Problem with setting P = AC
• Loss of price signal to consumers
• Increases need for (expensive) peak capacity
• Increases costs and prices
Setting Regulated Prices for a Natural Monopoly
Output/hr
Price/unit
0
MC
QR = Qc
Demand
ACFIXED CHARGE 固定支付
Solution 2:Two-part tariff: Usage charge PR = MCFixed charge = [AC (Qc)-MC (Qc)] * Qc
PR
AC (QR)
Cost-Based Regulated Price for Natural Monopoly
Regulated price =
Fixed costs (amortization in current year)
+
Operating costs
+
return onequity anddebt capital
Problems with Cost-Based Regulated Pricing
Setting regulated price = fixed costs + operating costs + return on capital invested
•Inadequate incentives for efficiency
•Need for significant regulatory supervision
•Tendency for “gold-plating”
Price Cap: Alternative to Cost-Based Regulated Prices
Revenues in base year Rb = costs in base year
Revenues in following year = Rb (1 + Ab)
Revenues in year t Rt = Rt-1 (1 + At) t = 2,….n
At = adjustment in firm’s prices based on inflation and technological change OR average cost increase for sample of comparable firms.
If firm’s increase in costs in year t < At
→ the firm gets to keep the difference→ incentive to be cost efficient
However, firm must be subject to quality standards.
Otherwise it can cut costs and reduce quality.
Strategic Positioning
Prefer cost-based or price cap regulation?
Risk Reward
CorporateMentality
StrategicOutlook
