Economics of Regulation (Course - 608) Delhi School of Economics
Winter Semester 2015-16 Instructor: Sugata Bag, email: sugata"at"econdse.org.
Time and Location: Tuesdays and Thursday 11:40 -12:50, Room No. AMEX Contact Hours: During lunch hour on every lecture days
Description of the Course
The objective of this course is to introduce you to the role of government in altering market outcomes when either competitive forces are weak or competitive equilibrium fails. It draws from areas such as welfare economics, public economics, and industrial organization. The focus is on monopolies, especially natural monopolies and potentially monopolised markets, where market mechanisms are unlikely to produce outcomes that benefit consumers more than the alternatives involving costly government intervention. The two main areas examined are competition policy and economic regulation. Competition policy refers to laws that define certain market behavior as illegal because it is harmful to competition or fails to provide consumer benefits that justify its costs to consumers.
Economic regulation refers to policies in which government controls prices and/or decides the terms and conditions under which firms can participate in a market. A growing area of study and policy design is the introduction of market mechanisms into formerly regulated industries such as:
telecommunications, electricity, airlines, railroads, postal delivery services and environmental regulation.
The course is roughly organized as follows. First few lectures will be devoted to competition policy issues, which introduce the economic mechanisms that cause the market failures used to justify economic regulation. Private vs. Private enterprises. The course will then turn to the study of economic regulation and the introduction of market mechanisms into regulated industries. In this part the focus will be on optimal regulation under various a/symmetrical informational situations prevailing between regulator and regulated firm/s. Regulation of innovation and patenting. Lastly, certain case studies will be taken up – regulation of energy market (e.g. electricity, crude oil, natural gas), railways privatisation.
Texts for the course: (in order of importance)
1. [VVH]. W. Kip Viscusi, John M. Vernon, and Joseph E. Harrington, "Economics of Regulation and Antitrust, 4th Edition", (Cambridge, MA: MIT Press, 2005).
2. [JOS] Joskow, Paul, 2006, “Regulation of Natural Monopolies”, Handbook of Law and Economics.
3. [AS-03]. Armstrong, Mark and David Sappington, “Recent Developments in the Theory of Regulation”, 2003. Only Sections: Pages. 1-24 (till 2.2.2); Section 3 (upto 3.1.3) pp. 41-48.
4. [AS-05]. Armstrong, Mark and David Sappington, “Regulation, Competition and Liberalization”, 2005. Pages. 1-28 only.
5. [MM] Motta, M., “Competition Policy: Theory and Practice”, 2004, Cambridge University Press, Cambridge, MA.
6. [RS] Sherman, Roger, “Regulation of Monopoly”, 1989, Cambridge University Press, 2004, Cambridge, MA
7. [LT-93]. Jean-Jacques Laffont and Jean Tirole, “A Theory of Incentives in Procurement and Regulation”, 1993. Introduction Chapter only.
These texts would be supplemented by other readings (especially papers) will be posted time to time in the course website.
Grading & Exams: There will be one midterm examination AND one term paper and presentation
((max 2 in a group) depending upon the class size)]. You should start looking for a topic (list below) for
the term paper at the very onset (which should be done in consultation with me) on a prominent
competition policy, an important regulatory policy, or industry re-structuring issue. Students should
identify their paper topic with a one-page written proposal due February 15, 2016. Final papers will be
due at the towards end of lectures. Please refer to chapters 16, 17 and 18 of VVH and last 4 four
chapters of Sherman in this regard. The midterm will be given in class and is scheduled for End of Feb.
The final exam is scheduled during the regular examination period. All the exams would be closed book. There would be NO MAKE-UP test in any circumstances. Presentations of the term papers may happen towards the end of semester. Grading will be based on the examinations and term paper presentation as follows:
One Midterm 15%
Term paper cum Presentation: 15%
End term Exam 70%.
Course Outline:
1. The Role of Government. Introduction to the course. The making of a regulation. Possible instrument choices. Why one instrument over another? Social Cost Benefit Analysis. Consequences of regulation.
i. Read: VVH Chapters 1,2 and 4.
2. Introduction to Economic Regulation. Motivation behind economic regulation. Potential instruments for regulation. Goals of regulation. Historic background.
i. Read: VVH Chapter 10. , JOS (pp. 34-53)
3. Theories of regulation: normative and positive analysis, interest groups theory i. ( VVH ) Chap 4
ii. Posner , R. A. 1974 " Theories of Regulation" , Bell Journal of Economics and Management Science, 25 (1), Spring, pp. 335- 373.
iii. Stigler, J. G. 1971, "The Theory of Economic Regulation," Bell Journal of Management Science, 2 (1), Spring, pp. 3 - 21.
iv. Peltzman, S. 1989 "The Economic Theory of Regulation after a Decade of Deregulation," Brookings Papers on Economic Activity: Microeconomics, pp. 1 - 41.
4. Public Enterprise. The origins of public ownership as a way to regulate economic activity. Public vs Private ownership. Does the threat of nationalization/municipalization discipline private firms?
i. VVH Chapter 14.
ii. Willner (2004)
iii. Vickers and Yarrow (1988) 5. Regulating Natural Monopolies:
(a) Pricing strategies, Rate Structure (RoR, RPI-X), Peak load pricing. Consequences: Averch- Johnson effect. Electric Power Example.
i. VVH Chapter 11, 12. ; JOS (pp. 76-93; 96-119)
ii. Baumol W. J. and D. F. Bradford, 1970, "Optimal Departures from Marginal Cost Pricing," American Economic Review, Vol. 60, No. 3, pp. 265-83.
iii. Ramsey, 1927, "A Contribution to the Theory of Taxation," Economic Journal, Vol.
37, No. 1, pp. 47-61.
iv. AS-05: Section 2A, 2B (pp 4-8): Recent Experience with Liberalization ;
v. AS-03: Section 3.2.4 Choice of ‘X’ in Price Cap Regulation (pp. 59-60); Sections 3.4 (pages. 63-67); Section 4.1 (pages. 71-75)
vi. Alexander, I and T. Irwin ( 1996)- Price Caps, Rate of Return Regulation and the Cost of Capital, World Bank, Note 87
vii. Averch. H., and L. L. Johnson, 1962, "Behavior of the Firm under Regulatory Constraint" ,American Economic Review, Vol. 52, No. 5, pp. 1053-1069
(b) Sustainability of natural monopolies and contestability i. ( VVH ) Chap 11, JOS (pp.7-31)
ii. Baumol, W. and R. Willig 1981 " Fixed Costs, Sunk Costs, Entry Barriers and Sustainability of Monopoly ", Quartely Journal of Economics, 95, August, 405-431
6. Regulating Natural Monopolies (Under Asymmetric Information):Problems of natural monopoly and Conventional theory of regulatory policy solutions (including optimal policies).
i. Read: *VVH, Chapters 10 and 11., JOS(pp.120-153)
ii. Baron-Myerson (1992) iii. Baron-Besenko
iv. Laffont, JJ. and Tirole, J. (1993). A Theory of Incentives in Procurement and Regulation. Introduction Chapter.
v. * Two Hand-outs on Hidden Info and Moral Hazard Models in monopoly set.
vi. *AS-05: Section 3: Regulated Monopoly and Unregulated Competition (pp. 8 -15) vii. AS-03: Upto 2.2.2 (pp. 1-24) & Section: 2.4 (pp. 35-40)
viii. Demsetz, H., "Why Regulate Utilities?", Journal of Law and Economics, 1968, pp.
55-65.
7. Franchise Bidding: The Case of Cable Television. Using franchise bidding as an alternative to regulation in the case of a natural monopoly.
i. * VVH Chapter 13. ; JOS (65-70)
ii. AS-05: pp 24-29 Or, AS-03: Section 4.2 (pp. 76-80) 8. Regulation of Innovation & Patents.
i. Read: VVH chapter 24.
CASE STUDIES
9. Dynamic Issues in Natural Monopoly Regulation: Telecommunication Example. What should a regulator do when an industry transforms over time due to exogenous changes that can either (1) change the optimal price or (2) change the industry from a natural monopoly into “something else”?
i. Read: VVH Chapter 15.
10. Dynamic Issues in Natural Monopoly Regulation: Telecommunication Example 2. The regulation of wireless telephony. Importance of common standards. Lessons from European Spectrum Auctions.
i. Read: Klemperer, P. (2002), How (not) to run auctions: The European 3G telecom auctions, European Economic Review, Vol.46, No.4-5, pp.829-845.
11. Regulation of Energy Markets : Crude oil & Natural Gas.
i. Read: VVH Chapter 18.
12. Problems of regulation: The case of UK Railway Privatisation. Background to the restructuring.
Regulatory changes and problems. Assessing the effects. Possible remedies.
i. Read: Pollitt, M.G. and Smith, A.J. (2002) The Restructuring and Privatisation of British Rail: Was it really that bad?, Fiscal Studies, Vol.23, No.4, pp.463-502.
13. Problems of regulation 2: The Case of Californian Electricity Deregulation. The nature of the reforms in California. How regulatory failure occurred. The costs of regulatory failure. Lessons for deregulation.
i. Read: Joskow, P. (2001), “California’s electricity crisis.” Oxford Review of Economic Policy, 17(3): pp.365-388.
14. Externalities. Positive and negative externalities. Market “failure” and forms of government intervention. Property rights and common property resources.
i. Read: VVH, chapter 19.
Term Paper Topics
1. Regulation of Energy Market
a. Regulating Petroleum Product Prices b. Rent Control and Natural Gas Field Prices
c. Electricity Market (Production Cost, Price, Subsidy) Regulation 2. Regulation of Transport
a. Urban Public Transport (taxi, Trucking)
b. Competition Airline regulation (Price Controls, Route Award, Supporting State owned Airline, Occupancy)
3. Regulation of Telecom 4. Regulation of Pharmaceuticals
5. Regulating Urban Piped Water Market
Or any other topic that is relevant to the course.
