Understanding Regulation: Theory, Strategy, and Practice

By Robert Baldwin; Martin Cave | Go to book overview

15
Price Setting in Natural Monopolies

This and the following four chapters are concerned with economic regulation of the utilities sector. This chapter focuses on the nature and implications of natural monopoly--a condition that governs the costs of many activities undertaken by utilities, especially their distribution networks. Natural monopoly can be defined as a situation in which the market can most cheaply be supplied by a single firm. (A gas distribution network is a good example.) A natural monopolist, left to itself, would for reasons discussed below be likely to charge excessive prices and there is accordingly a need for some form of price regulation, and scope for debate about the kind of price regulation that is appropriate.

Not all activities undertaken by utilities are naturally monopolistic, though historically the markets may for policy reasons have been supplied by a single firm, typically a public enterprise. In such cases, decisions have to be made about where, how, and when to liberalize the market and allow competition to enter. It is therefore necessary to discuss how to manage the transition to competition and the implications for regulating entry, prices, and quality of service. These issues are tackled in the following four chapters which deal, respectively, with the complementary roles of competition and regulation (Chapter 16), methods of price control (Chapter 17), the measurement of efficiency (Chapter 18), and regulating quality of service (Chapter 19).


1. What is a Natural Monopoly?

A natural monopoly arises when the market is served most cheaply by a single firm, rather than by a multiplicity of competing firms.1 In cases where

____________________
1
See M. Armstrong, S. Cowan, and J. Vickers, Regulatory Reform: Economic Analysis and British Experience ( London, 1994), chs. 2-3; S. Berg and T. Tschirhart, Natural Monopoly Regulation ( Cambridge, 1988); W. W. Sharkey, The Theory of Natural Monopoly ( Cambridge, 1982); C. D. Foster, Privatisation, Public Ownership and the Regulation of Natural Monopoly ( Oxford, 1992), ch. 6.

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Understanding Regulation: Theory, Strategy, and Practice
Table of contents

Table of contents

  • Title Page iii
  • Acknowledgements v
  • Contents vii
  • Figures ix
  • Tables x
  • Abbreviations xi
  • I- Introduction 1
  • 1- FUNDAMENTALS 7
  • 2: Why Regulate? 9
  • 3: Explaining Regulation 18
  • 4: Regulatory Strategies 34
  • 5: Who Regulates? Institutions and Structures 63
  • 6- What is 'Good' Regulation? 76
  • 7- The Cost-Benefit Testing Of Regulation 86
  • 8: Enforcing Regulation 96
  • 9: Setting Standards 118
  • 10: Self-Regulation 125
  • 11: Regulating Risks 138
  • 12: Regulation in the European Context 150
  • 13: Regulatory Competition and Coordination 180
  • 14: British Utilities Regulation 190
  • II- PARTICULAR CONCERNS 201
  • 15: Price Setting in Natural Monopolies 203
  • 16- Regulation Versus Competition 210
  • 17- Price-Capping Mechanisms 224
  • 18- Measuring Efficiency: Benchmarking, Yardsticking, and Performance 239
  • 19: Regulating Quality 248
  • 20: Franchising and its Limitations 257
  • 21: Accountability 286
  • 22: Procedures and Fairness 314
  • 23- Conclusions 334
  • Bibliography 337
  • Index 359
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