ECO 435 – Natural Monopoly Problem

David Loomis

To mimic a competitive market outcome even when the underlying market is not competitive

“other goals”◦ Fair and just rates◦ Specific policies regulators believe to be in

customers’ best interests◦ Universal service◦ Affordability◦ Economic development

Fundamental Goal of Regulation

Maximizes the sum of consumer and producer surplus

Productive and allocative efficiency

Competitive Ideal

Natural Monopoly◦ Firms builds pipeline costing $365 million with

capacity of 1 million cubic meters; has to repay $36.5 million/yr

◦ If it transports 100 cubic meters per day, AC=$1,001/cubic meter

◦ If it transports 1,000 cubic meters per day, AC=$101/cubic meter

◦ Also AC of building pipe decreases as size of pipe increases/cost=circumference, production=volume

Barriers to entry

Factors that Preclude a Competitive Outcome

Uncertainty about costs – imperfect information

Other regulatory interventions – Renewable Portfolio Standards (RPS) – increasing costs

Other Complicating Factors

See Notes

B&T 2.1, 2.2 and 2.5