Regulation of Monopolies

Monopolies create inefficiency and redistribute wealth from consumers to producers. The government intervenes to protect competition or regulate natural monopolies. How is this done, and what are the consequences?

Antitrust Legislation

Goals:

Prevention of abuse of market power
Protection of competition
Efficiency and innovation

Tools:

Prohibition of cartels: collusion on prices, division of markets
Merger control: blocking deals that create excessive concentration
Prohibition of abuses: predatory pricing, exclusive contracts
Forced breakup: splitting up monopolies (rarely)

Examples:

Standard Oil (breakup, 1911)
AT&T (breakup, 1984)
Microsoft (lawsuit, 2000s)
Google, Facebook (modern lawsuits)

Regulation of Natural Monopolies

Natural monopolies cannot be separated — a single producer is more efficient. But an unregulated monopoly will abuse its power.

Variants:

State ownership: traditionally for utility services
Private monopoly with price regulation: rate-of-return regulation, price caps
Franchise bidding: competition for the right to be the monopolist

Price Regulation

Marginal Cost Pricing ($P = MC$):

Achieves allocative efficiency
Problem: with natural monopoly, $MC < AC$
Requires subsidies

Average Cost Pricing ($P = AC$):

Firm is break-even
Does not achieve efficiency ($P > MC$)
Compromise between efficiency and financial sustainability

Rate-of-Return Regulation:

The regulator sets an acceptable rate of return on capital
Problem: Averch-Johnson effect — incentive for excessive capital
Complexity: defining a “reasonable” rate, assessing capital

Price Caps (RPI − X):

Price can rise no faster than inflation minus efficiency factor
Stimulates cost reduction (the firm keeps the savings)
Used in the UK and other countries

Deregulation

Trend of the 1980s-2000s: deregulation of many industries.

Arguments for:

Technological changes reduce the naturalness of monopoly
Regulation creates inefficiencies and regulatory capture
Competition stimulates innovation

Examples:

Aviation (USA, 1978)
Telecommunications
Electricity (splitting into generation/transmission/distribution)

Results: mixed. Price reductions in some sectors, quality issues in others.

Modern Challenges: Tech Monopolies

Characteristics:

Network effects
Platform business models
Data as an asset
Zero marginal costs

Questions:

Are traditional approaches applicable?
How to measure market power when prices are zero (Google, Facebook)?
How to account for innovation dynamics?

Discussions:

Big Tech breakup
Data portability
Interoperability requirements
Platform regulation

For Investors

Regulatory risk:

Companies with market power are under scrutiny
Antitrust lawsuits — material risk
Price regulation — limits upside

Analysis:

What regulation is the company subject to?
What is the probability of tightening?
How does regulation affect margin?

Regulated utilities:

Stable cash flows
Limited growth
Dividend plays