Class 12s

Class 12s - Department of Economics LeBow College of...

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Department of Economics Fall 2009 LeBow College of Business Economics 301 Drexel University Professor Stehr Class 12 Outline 1) Natural monopoly 2) Regulation of monopoly 3) Pricing discrimination Natural Monopoly -- a market where economies of scale are such that one firm can produce market output at lower cost than if there were several firms (or, when one firm can meet market demand at lower average cost than two or more firms) Network utilities such as electricity transmission, water, sewer, phone, natural gas, and cable TV are natural monopolies because of large fixed and sunk cost of establishing a service network What if we had two firms in a market with natural monopoly? Each would incur the fixed cost, so average cost would increase (2 Comcasts). We want to have monopoly to get economies of scale, but don’t want monopoly pricing What to do? One approach is regulation 1
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Regulation of Monopoly in Theory 1) P=MC. “first best” pricing because it’s socially optimal 2) P=AC “second best” lowest possible price without firm exiting. Problems with P = MC and P = AC regulation a) Very difficult to know MC, so 1 st best price regulation is impractical. Also difficult to know average cost and demand functions with certainty. b) 2
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c) d) regulatory lag—it may take along time to adjust prices correctly in response to changing cost or demand conditions because of bureaucracy at the regulatory agency Regulation of Monopoly in Practice
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This document was uploaded on 10/17/2011.

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Class 12s - Department of Economics LeBow College of...

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