The Case of Natural Monopoly

‭The case of natural monopoly‬ ‭ )‬ a ‭Presentation:‬ ‭When‬‭Increasing‬‭returns‬‭to‬‭scale‬‭,‬‭the‬‭market‬‭structure‬‭that‬‭naturally‬‭emerges‬‭is‬‭monopoly:‬‭any‬ ‭increase‬ ‭in‬ ‭the‬ ‭scale‬ ‭of‬ ‭Y‬ ‭results‬ ‭in‬ ‭a‬ ‭decrease‬ ‭in‬ ‭the‬ ‭CM.‬ ‭This‬ ‭is‬ ‭the‬ ‭case‬ ‭for‬ ‭activities‬ ‭with‬ ‭significant‬‭fixed costs‬‭, which require a very high volume of Y to be profitable.‬ ‭For a given market, the Y is then ensured by 1 single E whose CM is minimal - because the‬‭+ gde‬ ‭E has lower costs (if well managed) so it prevents entry of new firms because they can set‬ ‭lower prices.‬ I‭n these cases he‬‭better 1 E on the market because‬‭it allows lower prices‬‭.‬ ‭Pb:‬‭prices are optimal for the consumer when the price‬‭is equal to the Cma‬‭.‭B ‬ ut in a natural‬ ‭ onopoly, Cma < Cmo therefore the E makes losses‬‭.‬‭It must therefore be helped by the State.‬ m ‭Other problem:‬‭THE‬‭Lack of competition in these sectors‬‭can still lead to a sub-optimal‬ ‭situation.‬‭The following‬ ‭examples illustrate everything that has just been said.‬ ‭-We will remember that in‬‭some cases‬‭, competition‬‭is not always desirable.‬ ‭ )‬ b ‭Natural monopoly diagram and explanations‬‭:‬‭Context‬‭:‬ ‭Decreasing Cma and Cmo and large fixed costs.‬ ‭If we privatize and leave a monopoly‬‭, then E produces‬‭until Rma=Cma - big social loss: very‬ ‭high prices therefore little C.‬ ‭If we privatize and set prices where Cma=Rmo‬‭-low price‬‭so lots of C on service. But this‬ ‭induces losses for the E and therefore requires subsidies (see Ramsey-Boiteux).‬ ‭If we privatize and set the price where Cmo=Rmo: operator is in equilibrium (no subsidy). But high‬ ‭price, not necessarily fair for everyone (solution in Ramsey-Boiteux).‬ ‭ uler‬ R ‭Ramsey-Boiteux‬‭:‬ ‭Natural monopoly makes losses if it fixes its price at the Cma because it bears initial fixed cost.‬ ‭Average cost pricing: operator is in equilibrium but prices are more expensive. This may not be‬ ‭good in the context of a public service, especially for the less wealthy.‬ ‭The solution is to tax at the Cmo (therefore recover the fixed costs) where the D is the least elastic‬ ‭and to tax at the Cma where it is the most elastic.‬‭The‬‭margin rate associated with the‬ ‭Ramsey-Boiteux tariff is therefore a decreasing function of the price elasticity of D.‬ ‭Ex: For train tickets, we cover the fixed costs on the SNCF pro fares, and we charge the Cma for‬ ‭households in 2‬ ‭ndeclass.‬ ‭ )‬ c ‭How can natural monopolies be best managed?‬ ‭Laffont‬‭And‬‭Tirole‬‭,‭T ‬ HE theory of Incentives in Procurement‬‭and regulation‬ ‭,‬‭1993:‬‭Regulation theory:‬‭By integrating the fact that‬‭we have imperfect information‬ ‭and opportunistic behavior.‬‭We can go through incentive‬‭contracts:‬ ‭-‬‭Weak‬‭:producer assured in advance that its costs‬‭will be covered (‬‭no incentive to be efficient,‬ ‭control necessary‬‭)‬ ‭-‬‭Strong‬‭:‬‭we establish a fixed price contract - if‬‭E improves, the profit is for her.‬ ‭Strong incentive is therefore more effective. But has strong limits: can lead to less safety and‬ ‭quality to make a profit (lower spending).‬ ‭ e can go through competition:‬ W ‭Allows you to reveal the costs - e.g. rails in Italy (see below)‬ ‭ onsequences: quadruple reforms over the last 30 years:‬ C ‭-Use of ceiling prices (strong incentive)‬ ‭-Opening of the designed‬ ‭-Rebalancing of prices (TGV line cheaper than TER where there is no one);‬ ‭-Transfer of regulation to independent authorities.‬ ‭d)‬ ‭Opening of European networks (natural monopolies) through‬ ‭the example of rail:‬‭Italy, the opening to competition‬‭has proven‬ ‭ ositive:‬‭2001: the‬‭Ferrovie dello Stato Are‬‭separated‬‭into 2 entities:‬ p ‭-The railway network (rails) managed by the company‬‭RFI‬‭-natural‬‭monopoly.‬ ‭-The train company -‬‭Trenitalia‬‭.‬ ‭We then have the possibility‬‭of opening the design,‬‭because other E can use the rails in‬ ‭exchange for a fee.‬‭This‬‭fear of conception allowed‬‭Trenitalia to send the message to the‬ ‭unions that without reform, there is a risk of bankruptcy -‬‭The FS, which were over 240k in the‬ ‭80s, are now only 120k. And prices were reduced by 50% between Milan and Rome‬ ‭between 2011 and 2017‬‭. Italo, the private operator‬‭which has the lowest prices in Europe, has‬ ‭pushed Trenitalia to lower its prices and increase quality.‬ ‭ K: Privatization accompanied by too little subsidy has led to a sub-optimal situation:‬ U ‭Complete privatization, especially of the rails - errors.‬ ‭Pk? The UK had issued a call for tender (AO) for an E to recover the‬‭South Western‬ ‭Railway‬‭(SWR). To win the AO, an E had agreed to benefit‬‭from very little subsidy. However, we‬ ‭then had poor maintenance of the rails which caused several accidents. There‬‭SWR could be‬ ‭temporarily renationalised, after losing £100m in 2019.‬ ‭ k UK operators receive subsidy? because pricing at marginal cost - on a natural monopoly, this‬ P ‭induces losses (Ramsey-Boiteux).‬ ‭ rance: A necessary reform of a sub-optimal natural monopoly:‬ F ‭SNCF is 30% more expensive than any other company in Europe at comparable level‬‭. This‬ ‭because:‬ ‭-Special retirement plan‬ ‭-Organization of the L‬ ‭-Refusal of versatility‬ ‭-Necessary to reform SNCF before opening to the design because otherwise it will not win the AO.‬ -‭ Summary:‬‭services‬‭public can be implemented by AO‬‭and must be compensated for their‬ ‭deficit missions by the payment of a budgetary subsidy to the operator who carries out the‬ ‭missions concerned‬‭(ex: STIF subsidizes rail networks‬‭in IdF)‬ ‭-Experience has shown that the separation between infrastructure and service can be good:‬ ‭the State manages infrastructure (rails) better than the private sector, and we open the‬ ‭service to the designed for better allocation of resources.‬