Syllabus 2012-13 Economics of Regulation

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Economics of Regulation (Course - 608) Delhi School of Economics

Winter Semester 2012-13

Instructor: Sugata Bag, email: [email protected].

Time and Location: Tuesdays and Fridays 13:50 -15:00, Room No. AMEX Texts for the course:

1. VVH. "Economics of Regulation and Antitrust 4th Edition", W. Kip Viscusi, John M.

Vernon, and Joseph E. Harrington (Cambridge, MA: MIT Press, 2005).

2. AS05. “Regulation, Competition and Liberalization”, Armstrong, Mark and David Sappington, 2005. A-S-05

3. AS03. “Recent Developments in the Theory of Regulation”, Armstrong, Mark and David Sappington, 2003. A-S-03

Grading & Exams: There will be one midterm examination, And/Or, there may one (group) term paper and presentation (depending upon the class size). 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 start soon after the midterm exam. Grading will be based on the examinations and term paper presentation as follows:

Midterm 15%

Termpaper/Presentation 15%

Final 70%.

Description of the Course

The objective of this course is to introduce you to the role of government in altering market outcomes when competitive equilibrium fails. It draws from areas such as welfare economics, public economics, and industrial organization. In this course we will emphasize the importance of market structure and industrial performance, including the strategic interaction of firms. We will examine the behaviour of individual markets in some detail, focusing on cost analysis, the determinants of market demand, investment behaviour, market power, and the implications of government regulatory behaviour on natural monopolies and regulatory options for dealing with them.

Course Outline Regulatory Economics

1. Economics of Regulation: Introduction, Motivation behind economic regulation. Potential instruments for regulation. Goals of regulation. (1 lectures). Read: VVH, Chapters 1 and 10.

2. Theory and Regulation of Natural Monopoly: Problems of natural monopoly and Conventional theory of regulatory policy solutions (including optimal policies) for natural monopolies. (4 lectures).

Read: *VVH, Chapters 10 and 11.

*Armstrong-‐Sappington (2003): section 2 various with Asymmetric Information.

Demsetz, H., "Why Regulate Utilities?", Journal of Law and Economics, 1968, pp. 55-‐65.

3. Rate of Return Regulation: Pricing strategies, rate structure, peak load pricing.

Consequences: Averch-Johnson effect. Regulating rate of return on capital.

Public Enterprise as a way to regulate economic activity. Public vs. Private ownership. Does the threat of nationalization discipline private firms? (3 lectures)

• Rate Cases and Optimal Pricing. Read: VVH Chapter 12

• Rate-‐of-‐Return Regulation/Regulatory Strategies and Alternatives Read: *VVH Chapters 13 (Franchise Bidding) & 14 (Public Enterprise)

*Armstrong-‐Sappington (2003): sections 4.1 (Yardstick competition) pp. 72-‐76, 4.2 (Awarding franchise) pp. 81-‐84 *Armstrong-‐Sappington (2005) section 5 pp. 23-‐28

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4. Dynamic Issues in Natural Monopoly Regulation:. 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"? (1 Lecture)

Read: *VVH Ch.15 (Telecommunication Example)

5. Optimal Regulation under Asymmetric Information: Pricing and incentives for a single and multiproduct firm when the effort levels and technology type of the firm are not known to the regulator. Theory of yardstick competition. (6 lectures)

Read: *Armstrong-‐Sappington (2003): parts of section 4.1

Baron, D and Myerson R. (1982). Regulating a Monopolist with Unknown Cost.

Econometrica, 50: pp.911-‐930.

Shleifer, A. (1985) “A Theory of Yardstick Competition”, RAND Journal of Economics, 16:

pp. 319-‐327.

6. Pricing and Competition: Regulation under competition, access pricing and bypass (in the context of telecommunications and energy (power, gas) sectors (3 lectures)

Read: *VVH chapter 16.

*Armstrong-‐Sappington (2003) section 4.2. pp. 83-‐86

*Armstrong-‐Sappington (2005) section 3 subsections 3.1 through 3.3. pp. 8-‐15

Laffont, J.J. and Tirole, J. (1994) “Access pricing and competition”, European Economic Review, 38: pp. 1672-‐1710.

Armstrong, M., Doyle, C. and Vickers, J. (1996) “The access pricing problem: a synthesis”, The Journal of Industrial Economics, 44: 131-‐150.

7. Politics of Regulation and Regulatory Capture (4 lectures)

Read: A-‐S-‐03: section 2.2.2 pp.21-‐24, section 3 subsections 3.1.1 and 3.1.2 pp. 42-‐51, 3.4.2 pp. 69 Laffont, JJ. and Tirole, J. (1993). A Theory of Incentives in Procurement and Regulation. Parts of Chapter 11.

8. Social Regulation. (3 Lectures)

• Pharmaceuticals. Patents. Read: VVH Ch. 24.

• Regulation of the Internet: Should the state have protected Napster? The economics of copyright. The nature of the internet as a music distribution channel. What are the costs and benefits of tougher enforcement of record companies property rights? Read:

`fair use' in a networked world." and

o Boldrin, M. & Levine, D. (2002) “The case against intellectual property." AER, 92(2): pp.204-208 and pp.209-212.

• Externalities. Positive and negative externalities. Market failure" and forms of government intervention. Property rights and common property resources. Read:

VVH, Ch. 19.

Antitrust Issues:

9. Mergers &Vertical Relationship; Monopolization (3 Lectures)

*VVH chapters 7 & 8 (pp. 235-258), ch 9 (pp. 293-298, 305-317, 332-42) Armstrong-‐Sappington (2003): section 5

Vertical Restraints and Advertising

* VVH Chap. 8 (pp. 257-292)