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Chapter21 - MANAGERIAL ECONOMICS An Analysis of Business...

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1 MANAGERIAL ECONOMICS An Analysis of Business Issues Howard Davies and Pun-Lee Lam Published by FT Prentice Hall
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2 Chapter 21: The Economics of Regulated Industries Objectives: After studying the chapter, you should understand: 1. the various theories proposed to explain government regulation of businesses 2. the forms of government regulation like rate-of- return regulation, price-cap regulation, and franchise bidding 3. the world trend to privatisation and de- regulation
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3 Theories of Regulation 1. Public Interest Theory (or Consumer Interest Theory) 2. Private Interest Theory (or “Capture” Theory) 3. Regulation as Taxation 4. A General Theory of Regulation
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4 Public Interest Theory (or Consumer Interest)Theory Arguments for government regulation: Monopoly or natural monopoly Externalities: harmful or beneficial Provision of public good Imperfect information
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5 Private Interest Theory (or “Capture” Theory) Stigler and Friedland (1962): They formulated an econometric model to test the effect of regulation on electricity prices: Price = f(Population, Fuel, Income, Hydro, Dummy) Price = f(Population, Fuel, Income, Hydro, Dummy) Results: Regulation (the dummy variable) had insignificant effect on the average price of electricity; regulation was more likely to protect commercial and industrial consumers than domestic consumers.
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6 Capture theory of regulation (by Stigler) Government Regulations are designed to protect producers. Why protecting producers? (1) Bureaucrats - they gain from supplying regulations
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7 (2) Consumers - they are not well informed - they are not well organized A large group size, smaller individual gain, free-rider problem (3) Producers - better organized; benefits are concentrated
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8 Stigler's theory of economic regulation (1971) Asymmetrical distribution between gainers and losers from regulations. Larger damage to the majority will become small when spread among them.
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9 High costs of organising a large group. Members of industries with smaller size have greater incentive to acquire information and there are smaller costs of organising political activities.
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10 Regulation as Taxation (by Posner, 1971 and 1974) the public interest theory is flawed because case studies have shown that government regulation
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