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Lecture 35: Natural Monopoly & Public Utility Regulation

Lecture 35: Natural Monopoly & Public Utility Regulation. Natural Monopoly. Natural Monopoly MES large relative to market. Diagram 35.1. LRMC. £. LRAC. MES. MC m = AC m. Q m. Output. Demand. Natural Monopoly. Natural Monopoly MES large relative to market many firms  high costs.

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Lecture 35: Natural Monopoly & Public Utility Regulation

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  1. Lecture 35: Natural Monopoly & Public Utility Regulation

  2. Natural Monopoly • Natural Monopoly • MES large relative to market

  3. Diagram 35.1 LRMC £ LRAC MES MCm = ACm Qm Output Demand

  4. Natural Monopoly • Natural Monopoly • MES large relative to market • many firms high costs

  5. Diagram 35.2 LRMC £ LRAC ACs MES MCs MCm = ACm Qs Qm Output

  6. Natural Monopoly • Natural Monopoly • MES large relative to market • many firms high costs • monopolist  high price/low output

  7. Diagram 35.3 LRMC £ LRAC Pmono MES MCm = ACm Qmono Qm Output Demand MR

  8. Natural Monopoly • Natural Monopoly • MES large relative to market • many firms high costs • monopolist  high price/low output • Public ownership • marginal cost pricing (P = LRMC) • LRMC < LRAC • break even (P = LRAC)

  9. Diagram 35.4 LRMC £ LRAC MES P = LRAC AC* P = LRMC* Q Q* Qm Output Demand

  10. Natural Monopoly • Natural Monopoly • MES large relative to market • many firms high costs • monopolist  high price/low output • Public ownership • marginal cost pricing (P = LRMC) • LRMC < LRAC • break even (P = LRAC) • X-inefficiency • Regulation of privately-owned utilities in UK & USA

  11. Public Utilities • natural monopolies • large capital cost - network/grid • diminishing LRAC • single network efficient

  12. Electricity • Generation • Transmission • Distribution • Supply Natural monopoly restricted to network/grid

  13. Regulation of Utilities Unregulated natural monopoly  allocative inefficiency (P>Mc) • marginal cost pricing Regulation  UK: OFCOM, OFGEM (OFGAS, OFFER), OFWAT  USA: State utility commissions

  14. United States rate of return regulation • normal return on capital • average cost pricing (P=AC>Mc) • no incentives TR* = TVC +  K operating expenses normal return rate base

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