ECONOMIC REGULATION: Controlling price and other aspects of competition

GOAL: Prevent monopoly pricing

Antitrust/Competition law

• Acquisition of price-setting power

• Collusion to fix price

• Use of market power unfairly or unreasonably to squelch competition

Public Utility Regulation

• chartered monopoly

• administrative price setting

Government Ownership

1792 Tripp v. Frank (England)

1837 Charles River Bridge (U.S.)

1859 Edwin Drake struck oil in western Pennsylvania

1865 First natural gas utility opened in Fredonia, NY

1877 Munn v. Illinois

1882 Edison’s Pearl St. Station power plant opened

1887 Interstate Commerce Act

1880s- Rise of state utility commissions; passage of federal major antitrust legislation

1930s Federal Power Act; Rural Electrification Act; Public Utilities Holding Co. Act

1930s

Economic Regulation: Evolution of Legal Rules

Monopolization

• Under §2 of the Sherman Act, it is illegal to monopolize or attempt to monopolize.

• To tell if a monopoly is illegal, ask:– What is the market?– Does the company control the market?

• No matter what your market shares, you do not have a monopoly unless you can exclude competitors or control prices.

MonopolizationHow did the Standard Oil acquire its

dominant share in the oil market?

• Originally, Standard Oil professionalized and improved the quality of the oil refining business

• This increased the cost of entry

• Rockefeller excelled at eliminating waste and minimizing costs while maintaining quality.

MonopolizationHow did the Standard Oil maintain its dominant

share in the oil market?

• Negotiated “rebates” from railroads. Why rebates? Why not just reduced rates?

• Consolidation plan

• buyouts +/or

• South Improvement Company

What exactly was the SIC? How did it work?

• Shipping/transportation control

• Vertical integration (upstream; downstream)

Artifacts of Standard Oil: U.S. antitrust laws prohibit

– price fixing / collusion– geographic market divisions– maintenance of a monopoly through “bad

acts”– certain forms of price discrimination– certain forms of resale price maintenance– mergers that will create firms with “monopoly

power”

Illegal monopolization

Illegal restraints of trade

Antitrust Law

Sources of Confusion in Antitrust Law

• Changing philosophies over time:– Movement away from presuming harm to

consumer (per se violations) and toward requiring government/plaintiff to prove harm (increasing application of rule of reason)

– Movement towards greater focus on effect on consumer in the long run

– Because these philosophical changes are new, different judges seem to apply different approaches, depending upon whether they subscribe to the old or the new philosophy

– DOJ/FTC enforcement policies vary according to the preferences of the presidential administration

1792 Tripp v. Frank (England)

1837 Charles River Bridge (U.S.)

1859 Edwin Drake struck oil in western Pennsylvania

1865 First natural gas utility opened in Fredonia, NY

1877 Munn v. Illinois

1882 Edison’s Pearl St. Station power plant opened

1887 Interstate Commerce Act

1880s- Rise of state utility commissions; passage of federal major antitrust legislation

1930s Federal Power Act; Rural Electrification Act; Public Utilities Holding Co. Act

1930s

Economic Regulation: Evolution of Legal Rules

MC

MR D

Price

PC

PM

QM QC Quantity

Inefficiency of Monopoly

Commission Regulation

COMMISSION FORM:

• Plural executive; appointed (feds) or elected (some states)

• Rate cases; few rulemakings

• “Staff” represents ratepayers

CONGRESS Staff PRESIDENT

COMMISSION

Intervenors

Regulated Firms

Commission Regulation

COMMISSION FORM:

• Plural executive; appointed (feds) or elected (some states)

• Rate cases; few rulemakings

• “Staff” represents ratepayers

REGULATORY PRINCIPLES:

1. “Natural” monopoly; certificate of convenience and necessity; duty to serve

Commission Regulation

COMMISSION FORM:

• Plural executive; appointed (feds) or elected (some states)

• Rate cases; few rulemakings

• “Staff” represents ratepayers

REGULATORY PRINCIPLES:

1. “Natural” monopoly; certificate of convenience and necessity; duty to serve

2. Cost-based rate setting; “fair” rate of return for shareholders on “prudent” investments

How might this “fair” return be established?

PUBLIC POWER MOVEMENT

1. Federal Power Agencies (TVA, BPA)

2. REA

3. Municipal power

4. Federal and municipal preferences

5. California in 2002?

Characteristics of modern, regulated public utility:

• Monopoly license within service area

• Duty to serve all

• Regulated rates

R = Br + O

• Under traditional rate regulation, how are rates set?

• What is a rate case? Procedurally, how does a rate case unfold? Who initiates it, and who else is involved?

R = Br + OWhat is “rate base”?

• Is all utility capital equipment included?

• Once the eligible assets are identified, how is a value assigned to that rate base?

• Suppose the state PSC miscalculates the value of a generating plant, overvaluing it by 30%?

R = Br + O• What is the rate of return?

• What sort of rate of return is the utility entitled to? What policy objectives underlie the requirement of a “fair” return on investment?

• How is this standard applied? How is the rate set?

R = Br + O• How closely do regulators scrutinize

expense claims made by utilities?

• What if the expenses were incurred imprudently?

• How are expenses calculated?

I.        TEXAS LIGHT AND POWER:

 Item Original cost($000) Year

Transmission facilities $1000 1995

Coal-fired plant $10K 1 1965

Rarely used solar plant $1000 1995

Cancelled nuclear plant $1000K 1995

Construction on new hydro plant $1000/yr. Since 1995

Railroad spur for coal delivery $100 1995

Assets of env consulting subsidiary $1000

Research into fusion power $1000

PURPA era hydro purchase contracts $100/yr.

Executive salaries $1000/yr.

Attorney’s fees $1000/yr.

Contribution to Ch. of Scientology $100/yr.

Contribution to local food bank $100/yr.