economics of government intervention · why regulate? • public interest argument • conceptual...
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Economics of Government Intervention
Lynne KieslingCato University 2011
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Economic regulation(not exhaustive)
• Occupational regulation (min wages, advertising bans) and licensing
• Health & safety
• Environmental
• Antitrust/competition policy
• Natural monopoly regulation
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Freedom of innovation and market entry
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Monopoly• Do markets tend toward monopoly?
• Negative effects of monopoly: high prices, deadweight loss, bad for consumers
• If monopolies do arise in markets, do they persist? If so, why?
• “Secret recipe”, some particular skill or technology, ownership of a natural resource
• Government entry barriers: patents, regulation, etc.
• If so, is there justification for government intervention?
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Disciplining monopoly: consumer demand, competition, innovation
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Dynamics of competition• Joseph Schumpeter
• Monopoly profits are the carrot that induces innovation: new products, new production techniques, new modes of organization
• Competition for market dominance
• Dynamism erodes the monopoly and renders it temporary
• “... the perennial gale of creative destruction”
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A hard case: the “natural monopoly”
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A whirlwind history of the electricity industry
• Whale oil?
• Edison/Tesla/Westinghouse “War of Systems”
• Late 19th c.: cities granted franchises to vertically-integrated utilities, initially rivalrous markets
• High fixed costs/capital costs, debt & equity funding
• Vertically integrated supply chain: generation, transmission, distribution, (lighting fixtures), retail
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Tesla’s turbines, Niagara Falls, 1895
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Why regulate?• Public interest argument
• Conceptual and common law precedents: Aquinas “just price”, common-law regarding “essential services”, Munn v. Illinois (1887)
• Populist era culture of suspicion of large companies
• Public choice theory argument
• Institutional bargaining between industry and policymakers
• Economic theory argument
• High fixed costs => economies of scale over the range of consumer demand
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“Standing in for competition”
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Some critiques of regulation• Did achieve low, stable prices and universal electrification ... but at a high cost
• Static market/product definition necessary
• Stifles innovation
• Asset investment incentive problems
• Incentive to overinvest and overbuild capacity
• Incentive to invest in “iron in the ground” reinforces lack of innovation
• Lack of cost management incentive problems
• Based on a static neoclassical model in a dynamic, and increasingly complex, environment
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What’s next? Smart grid.
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Smart grid technology & economics• Sensing, embedded computing capability and two-way communications in the electric power
network’ physical infrastructure
• Smart grid as a “network of networks”
• Transmission
• Distribution
• Wholesale power markets
• Distribution local area network
• Consumer’s home area network (HAN)
• Wide variety of technologies and capabilities through the network
• Digital technologies enable a paradigm shift from centralized control to decentralized coordination
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A smart grid is a transactive network
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Case study: GridWise Olympic Pensinula project
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Project summary• 2 hypotheses to test
• Does the tech/pricing combination change consumer energy use patterns (and therefore system)?
• Do consumers automate their responses?
• Participants chose among three contracts: Fixed, Time of Use (TOU), Real Time Price (RTP)
• RTP market clearing
• 5-minute intervals, with price-responsive appliances & ability to automate decisions
• Designed as a double auction
• First ever use of a double auction in a residential retail electricity market
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Testing market-based consumer incentives in a transactive network
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Real-time retail double auction
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Overall project results• Automation reduced transaction costs and increased responsiveness to price
signals
• Consumers saved money: 10% on average, highest for RTP
• Reduced overall consumption
• Reduced peak demand took strain off of infrastructure
• Implied reduction in wholesale electricity prices
• If extrapolated nationally, could lead to avoided investment in “iron in the ground” of $70 billion over 20 years
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Competitive retail markets are more likely to create and deliver
such benefits than regulated utilities
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The knowledge problem and the value of retail competition
“The economic problem of society is thus not merely a problem of how to allocate “given” resources ... it is rather a problem of how to secure the best us of resources known to any of the members of society, for ends whose relative importance only those individuals know.”
F. A. Hayek
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“Civilization advances by extending the number of important operations which we can perform without thinking of them.”
Alfred North Whitehead