Spring Semester 1995

Economics 220B
Regulatory Economics



January 18: Overview.
The Averch-Johnson model of the effects of rate-of-return regulation.

January 25: Continuation of A-J model.
Mechanisms to induce optimality with one-product firms.

February 1: The effects of uncertainty.

February 8: Ramsey pricing.

February 15: The Vogelsang-Finsinger mechanism.

February 22: Surplus subsidy schemes.

March 1: Bayesian regulation.

March 8: Multi-part tariffs.
Two student presentations.

March 15: Time-of-use prices and Riordan's mechanism.
Two student presentations.
Take-home midterm passed out: due at noon on March 17.

March 22: Self-selecting tariffs and Sibley's mechanism.
Two student presentations.

March 29: Spring Recess: No class.

April 5: Price caps and "performance based" regulation.
Two student presentations.

April 12: Auctioning the monopoly franchise.
Characteristics of natural monopoly.
Two student presentations.

April 19: Sustainability, contestability, cross-subsidization.
Two student presentations.

April 26: Four student presentations.

May 3: Four student presentations.


Course requirements/grading:

Take-home midterm 15%
Final exam 30%
Class presentation 20%
Paper (same topic as presentation) 20%
Attendance 15%


Readings:


Articles marked with a * are required; they are included in the reader. OR refers to Train, Optimal Regulation (MIT Press.) This book synthesizes the issues related to each topic; it is required reading in addition to the starred articles (not as a substitute.) Other listed articles provide important insights for students who are interested in pursuing the topic further.


OVERVIEW

OR, Preface and Introduction


THE A-J MODEL

OR, Chapter 1

*Baumol and Klevorick, 1970, "Input Choices and Rate-of-Return Regulation," Bell Journal of Economics and Management Science, Vol. 1, No. 1, pp. 162-90.

*Courville, 1974, "Regulation and Efficiency in the Electric Utility Industry," Bell Journal of Economics and Management Science, Vol. 5, No. 1, pp. 53-74.

Averch and Johnson, 1962, "Behavior of the Firm under Regulatory Constraint," American Economic Review, Vol. 52, No. 5, pp. 1053-1069.

Bailey, Elizabeth, 1973, Ch. 5-9, Economic Theory of Regulatory Constraint, Lexington Books.

Zajac, 1970, "A Geometric Treatment of Averch-Johnson's Behavior of the Firm Model," American Economic Review, Vol. 60, No. 1, pp. 117-125.

Spann, 1974, "Rate of Return Regulation and Efficiency in Production: An Empirical Test of the Averch-Johnson Thesis," Bell Journal of Economics and Management Science, Vol. 5, No. 1, pp. 38-52.

Peterson, 1975, "An Empirical Test of Regulatory Effects," Bell Journal of Economics, Vol. 6, No. 1, pp. 111-126.


MECHANISMS FOR OPTIMALITY WITH ONE-PRODUCT FIRMS

OR, Chapter 2.

Bailey, Elizabeth, 1973, Ch. 4, Economic Theory of Regulatory Constraint, Lexington Books.


THE EFFECTS OF UNCERTAINTY

OR, Chapter 3

*Peles and Stein, 1976, "The Effect of Rate of Return Regulation is Highly Sensitive to the Nature of Uncertainty," American Economic Review, Vol. 66, No. 3, pp. 278-289.

*Das, 1980, "On the Effect of Rate of Return Regulation under Uncertainty," American Economic Review, Vol. 70, No. 3, pp. 456-460.

Rau, 1979, "On Regulation and Uncertainty: Comment," American Economic Review, Vol. 69, No. 1, pp. 190-4, plus reply by Peles and Stein, pp. 195-9.

Chang, 1991, "A Note on the Effect of Rate-of-Return Regulation Under Uncertainty," Journal of Regulatory Economics, Vol. 3, No. 4, pp 349-55, plus replies by Das, pp. 357-8, and Peles, pp. 359-60.


RAMSEY PRICING

OR, Chapter 4.

*Baumol and Bradford, 1970, "Optimal Departures from Marginal Cost Pricing," American Economic Review, Vol. 60, No. 3, pp. 265-83.

Ramsey, 1927, "A Contribution to the Theory of Taxation," Economic Journal, Vol. 37, No. 1, pp. 47-61.


THE VOGELSANG-FINSINGER MECHANISM

OR, Chapter 5.

*Vogelsang and Finsinger, 1979, "A Regulatory Adjustment Process for Optimal Pricing by Multiproduct Monopoly Firms," Bell Journal of Economics, Vol. 10, No. 1, pp. 157-71.

*Sappington, 1980, "Strategic Firm Behavior Under a Dynamic Regulatory Adjustment Process," Bell Journal of Economics, Vol. 11, No. 1, pp. 360-72.

Baron and Besanko, 1984, "Regulation, Asymmetric Information, and Auditing," Rand Journal of Economics, Vol. 15, No. 4, pp. 447-70.


SURPLUS SUBSIDY SCHEMES

OR, Chapter 6.

*Loeb and Magat, 1979, "A Decentralized Method for Utility Regulation," Journal of Law and Economics, Vol. 22, pp. 399-404.

*Sappington and Sibley, 1988, "Regulating without Cost Information: The Incremental Surplus Subsidy Scheme," International Economic Review, Vol. 29, No. 2, pp. 297-306.

Finsinger and Vogelsang, 1981, "Alternative Institutional Frameworks for Price Incentive Mecahnisms," Kyklos, Vol. 34, pp. 388-404.


BAYESIAN REGULATION

*Baron and Myerson, 1982, "Regulating a Monopolist with Unknown Costs," Econometrica, Vol. 50, No. 4, pp. 911-930.

Sappington, 1983, "Optimal Regulation of a Multiproduct Monopolist with Unknown Technological Capabilities," Bell Journal of Economics, Vol. 14, No. 3, pp. 453-463.

Laffont and Tirole, 1986, "Using Cost Observation to Regulate Firms," Journal of Political Economy, Vol. 94, No. 3, pp. 614-641.


MULTI-PART TARIFFS

OR, Chapter 7.

*Willig, 1978, "Pareto Superior Non-linear Outlay Schedules," Bell Journal of Economics, Vol. 9, pp. 56-69.

Panzar, 1977, "The Pareto Dominance of Usage Insensistive Pricing," in H. Dorick, ed., Proceedings of the Sixth Annual Telecommunications Policy Research Conference, Lexington Books.

Wilson, Robert, 1993, Nonlinear Pricing, Oxford University Press

Brown, Stephen, and David Sibley, 1986, The Theory of Public Utility Pricing, Cambridge University Press.


TIME-OF-USE PRICES AND RIORDAN'S MECHANISM

OR, Chapter 8.

*Williamson, 1966, "Peak-Load Pricing and Optimal Capacity under Indivisibility Constraints," American Economic Review, Vol. 56, No. 4, pp. 810-27.

*Riordan, 1984, "On Delegating Price Authority to a Regulated Firm," Rand Journal of Economics, Vol. 15, No. 1, pp. 108-15.

Aigner, ed., 1984, special issue of Journal of Econometrics on peak-load pricing, Vol. 26.

Mackie-Mason, 1990, "Optional Time-of-Use Pricing Can Be Pareto Superior or Pareto Inferior," Economics Letters, Vol. 33, pp. 363-367.


SELF-SELECTING TARIFFS AND SIBLEY'S MECHANISM

OR, Chapter 9.

*Sibley, 1989, "Asymmetric Information, Incentives, and Price-Cap Regulation," Rand Jorunal of Economics, Vol. 20, No. 3, pp. 392-404.

Train, 1994, "Self-Selecting Tariffs Under Pure Preferences Among Tariffs," Journal of Regulatory Economics, Vol. 6, No. 3, pp. 247-264.

Faulhaber and Panzar, 1977, "Optimal Two-Part Tariffs with Self-Selection," Bell Laboratories Economic Discussion Paper No. 74.


PRICE CAPS AND "PERFORMANCE-BASED" REGULATION

OR, Appendix

*Acton and Vogelsang, 1989, "Introduction" to Price Caps Symposium, Rand Journal of Economics, Vol. 20, No. 3, pp. 369-72.

*Brennan, 1989, "Regulating by Capping Prices," Journal of Regulatory Economics, Vol. 1, No. 2, pp. 133-47.

Articles for Symposium on Price-Cap Regulation, published in Rand Journal of Economicas, Vol. 20, No. 3, 1989.

Cabral and Riordan, 1989, "Incentives for Cost Reduction under Price Cap Regulation," Journal of Regulatory Economics, Vol. 1, No. 2, pp. 93-102.

Shleifer, 1985, "A Theory of Yardstick Competition," Rand Journal of Economics, Vol. 16, No. 3, pp. 319-327.

Salant and Woroch, 1992, "Trigger Price Regulation," Rand Journal of Economics, Vol. 23, No. 1, 1992.


AUCTIONING THE MONOPOLY FRANCHISE

OR, pp. 297-303.

*Demsetz, 1968, "Why Regulate Utilities?" Journal of Law and Economics, Vol. 11, No. 1, pp. 55-65.

*Williamson, 1976, "Franchise Bidding for Natural Monopolies -- In General and with respect to CATV," Bell Journal of Economics, Vol. 7, No. 1, pp. 73-104.

Posner, 1972, "The Appropriate Scope of Regulation in the Cable Television Industry," Bell Journal of Economics and Management Science, Vol. 3, No. 1, pp. 98-129.

Riordan and Sappington, 1987, "Awarding Monopoly Franchises," American Economic Review, Vol. 77, No. 3, pp. 375-387.

Laffont and Tirole, 1987, "Auctioning Incentive Contracts," Journal of Political Economy, Vol. 95, No. 5, pp. 921-937.

Zupan, 1989, "The Efficacy of Franchise Bidding Schemes in the Case of Cable TV: Some Systematic Evidence," Journal of Law and Economics.

Pager, 1990, "Firm Behavior in Franchise Monopoly Markets," Rand Journal of Economics," Vol. 21, No. 2, pp. 211-225.


CONTESTABILITY, SUSTAINABILITY, AND CROSS-SUBSIDIZATION

OR, pp. 303-315

*Baumol, 1982, "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, Vol. 72, No. 1, pp. 1-15.

*Schwartz and Reynolds, 1983, "Contestable Markets: An Uprising in the Theory of Industry Structure: Comment," American Economic Review, Vol. 73, No. 3, pp. 488-490.

Baumol, Bailey, and Willig, 1977, "Weak Invisible Hand Theorems on the Sustainability of Multiproduct Natural Monopoly," American Economic Review, Vol. 67, No. 3, pp. 350-365.

Faulhaber, G., 1975, "Cross-subsidization: Pricing in Public Enterprises," American Economic Review, Vol. 65, pp. 966-77.

Faulhaber and Levinson, 1981, "Subsidy Free-Prices and Anonymous Equity," American Economic Review, Vol. 71, No. 5, pp. 1083-91.

Panzar and Willig, 1977, "Free Entry and the Sustainability of Natural Monopoly," Bell Journal of Economics, Vol. 8, No. 1, pp. 1-22.

Panzar, J., 1989, "Technological Determinants of Firm and Industry Structure," Ch. 1 in Handbook of Industrial Organization, North-Holland.


Topics for Student Presentations


1. The Demand and Supply of Regulation: The "Chicago School" and capture Theory.
"Theories of Economic Regulation," Richard Posner, Bell Journal of Economics and management science, Vol. 5, No. 2, pp. 335-358, 1974.
"The Political Economy of Deregulation: The Case of Intrastate Long Distance," Kaserman, Mayo, and Pacey, Journal of Regulatory Economics, Vol. 5, No. 1, pp. 49-63, 1993.
"Regulatory Treatment of Adverse Outcomes: Empirical Evidence from the Electric Utility Industry," Nancy Ryan, Ph.D thesis, Department of Economics, University of California, Berkeley, 1991. (There is a copy in the main library, or call Nancy Ryan at Quantum Consulting, 540-7200.)

2. How to discipline the regulator. "Why Less May Be More Under Price-Cap Regulation," Dennis Weisman, J. of Regulatory Economics, Vol. 6, No. 4, pp. 339-362, 1994.

3-6. History and effects of deregulation in trucking, rail, long distance telecommunications, airlines:

3. Trucking:
"The Inefficiency of Regulating a Competitive Industry: Productivity Gains in Trucking Following Reform," John Ying, Review of Economics and Statistics, Vol. 72, No. 2, pp. 191-201, 1990
"Pricing in a Deregulated Environment: The Motor Carrier Experience," John Ying and Ted Keeler, RAND Journal of Economics, Vol. 22, No. 2, pp. 264-273, 1991.
"Deregulation and Scale Economics in the U.S. Trucking Industry: An Econometric Extension of the Survivor Principle," Ted Keeler, Journal of Law and Economics, Vol. 32, pp. 229-253, 1989.
"Market Access in Regulated and Unregulated Markets: The Continuing Cost of Interstate Motor Carrier Regulation," Wesley Wilson and Richard Beilock, Journal of Regulatory Economics, Vol. 6, No. 4, pp. 363-379, 1994.


4. Rail:
"The Costs of Price Regulation: Lessons from Railroad Deregulation," K. D. Boyer, RAND Journal of Economics, Vol. 18, pp. 408-416, 1987.
"Railroad Deregulation, Carrier Behavior, and Shipper Response: A Disaggregated Analysis," Mark Burton, Journal of Regulatory Economics, Vol. 5, No. 4, pp. 417-434, 1993.
"The Effects of United States Railroad Deregulation on Shippers, Labor, and Capital," Henry McFarland, Journal of Regulatory Economics, Vol. 1, No. 3, pp. 259-270, 1989.


5. Telecommunications
After the Breakup: U.S. Telecommunications in a More Competitive Era, Robert Crandall, Brookings Institute publication, Washington, DC
"Costly Gains to Breaking Up: LECs and the Baby Bells," John Ying and Richard Shin, Review of Economics and Statistics, Vol. 75, No. 2, pp. 357-361, 1993.


6. Airlines
The Economic Effects of Airline Deregulation, Morrison and Winston, Brookings Institute publication, Washington, D.C., 1986.
"The Dynamics of Airline Pricing and Competition," Morrison and Winston, American Economic Review, Vol. 80, No. 2, pp. 389-393, May 1990.


7. The Regulated Postal Monopoly.
"The Efficiency Costs of the Postal Monopoly: The Case of Third-Class Mail," Thomas Lenard, Journal of Regulatory Economics, Vol. 6, No. 4, pp. 421-432, 1994.
"Stand-Alone Costs, Ramsey Prices and Postal Rates," Thomas
Lenard and Monica Bettendorf, Journal of Regulatory Economics, Vol. 4, pp. 243-62, 1992.
Competition and Innovation in Postal Services, edited by Michael Crew and Paul Kleindorfer, Kluwer academic press, Boston.

8. Effects of regulation on regulated firm's entry into competitive markets.
"Diversification Incentives under 'Price Based" and 'Cost Based' Regulation," Ronald Braeutigam and John Panzar, RAND Journal of Economics, Vol. 20, No. 3, pp. 373-391, 1989.
"Comparing the Costs and Benefits of Diversification by Regulated Firms," Timothy Brennan and Karen Palmer, Journal of Regulatory Economics, Vol. 6, No. 2, pp. 115-136, 1994.

9. Allowing the firm to keep profits from efficiency gains will induce these gains but at the cost of consumers losing these extra profits. How do different regulatory procedures compare in this tradeoff between the benefits of efficiency versus the loss to consumers from high profits?
"Rent Extraction and Incentives for Efficiency in Recent Regulatory Proposals," Gasmi, Ivaldi and Laffont, Journal of Regulatory Economics, Vol. 6, No. 2, pp. 151-176, 1994.

10. Competition for intraLATA toll and local telephone service.

11. Incentives (to the utility and to the customer) for energy conservation, and the movement toward competition in energy.

12. Franchises versus competition for cable TV. "Competition and the Price of Municipal Cable Television Services: An Empirical Study," Beil, Dazzio, Ekelund, and Jackson, Journal of Regulatory Economics, Vol. 5, No. 4, pp. 401-415, 1993.

13. When might an unregulated monopolist charge Ramsey prices? "Weak Invisible Hand Theorems on the Sustainability of Multiproduct Natural Monopoly," Baumol, Bailey and Willig, American Economics Review, Vol. 67, No. 3, pp. 350-365, 1977.

14. Regulation of safety characteristics of products.
"Regulation of Product Safety Characteristics Under Imperfect Observability," Chan and Marino, Journal of Regulatory Economics, Vol. 6, No. 2, pp. 177-195, 1994

15. How to regulate an oligopoly? A variation on the Sappington and Sibley's incremental surplus subsidy scheme. "Regulating Oligopolistic Industries: A Generalized Incentive Scheme," Sylvia Schwermer, Journal of Regulatory Economics, Vol. 6, No. 1, pp.97-108, 1994.

16. When will a regulated firm expend funds on private benefits that have no productive purpose?
A comparison of ROR and ISS regulation. "Regulatory Incentive Policies and Abuse," Sappington and Sibley, Journal of Regulatory Economics, Vol. 5, No. 2, pp 131-141, 1993.



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