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1、Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationP13428 Economics of Regulation8. Solutions II: Franchise BiddingReading:Baldwin & Cave Chapter 20 (UK Background)Viscusi, Vernon & Harrington Chapter 13. (core reading)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Last Week:Considered

2、 regulation as a solution to the natural monopoly problemSaw that Maximum Price Regulation, e.g. RPI-X, is preferred to rate-of-return regulationExamined examples (and problems) from recent regulatory history.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12

3、 13 14 15 16 17 18 19Last Week:Considered regulation as a solution to the natural monopoly problemSaw that Maximum Price Regulation, e.g. RPI-X, is preferred to rate-of-return regulationExamined examples (and problems) from recent regulatory history.Lecture 8: Solutions II: Franchise BiddingEconomic

4、s of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Last Week:Considered regulation as a solution to the natural monopoly problemSaw that Maximum Price Regulation, e.g. RPI-X, is preferred to rate-of-return regulationExamined examples (and problems) from recent regulatory history.Lecture 8

5、: Solutions II: Franchise BiddingEconomics of RegulationThis Week:Understand Franchise Bidding as an alternative private-ownership solution.How could bidding for franchises achieve second-best pricing?Example US cable TV1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Introduction to Franchise Bidding

6、:Alternative to Regulation suggested by Demsetz (1968)Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationAllow private firm exclusive franchise.Auction-off franchise. Firms bid the price they will charge.1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Introduction to Franchise Bidding:A

7、lternative to Regulation suggested by Demsetz (1968)Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationAllow private firm exclusive franchise.Auction-off franchise. Firms bid the price they will charge.Government acts as auctioneer: can use descending English auction mechanism.With suf

8、ficient competition at the bidding stage price should be bid down to AC of the most efficient provider, who will earn normal profits.1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Theory of Franchise Bidding I:E.g. 4 firms potentially could supply the market. Differ in terms of efficiency.Firm 4 is

9、highest cost firm, AC4Firm 1 is lowest cost firm, AC1QPD=ARAC1AC2AC3AC4Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Theory of Franchise Bidding I:E.g. 4 firms potentially could supply the market. Differ in terms of efficiency.Firm 4

10、is highest cost firm, AC4Firm 1 is lowest cost firm, AC1QPD=ARAC1AC2AC3AC4P4P3P2P1Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationWhat is the lowest price Firm 4 would be willing to supply the market at?Answer - P4.Would earn only normal profit.1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

11、 17 18 19Theory of Franchise Bidding II:PQD=ARAC1AC2AC3AC4P4P3P2P1PAPBPCLecture 8: Solutions II: Franchise BiddingEconomics of RegulationNew bid PB Firms 1,2 accept.Who accepts?Firms 1,2,3.New bid PC Firm 1 accepts.So Firm 1 wins the exclusive franchise at price PC.Government runs an auction, bids:Y

12、ou can have an exclusive franchise to the market if you charge price PA (MR=AR=PA)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Theory of Franchise Bidding III: e: Firm 1 supplies market at price PC.PQD=ARAC1AC2P2P1PCLecture 8: Solutions II: Franchise BiddingEconomics of RegulationPast PC firm 1 kn

13、ows it is only possible supplier. If government lowered bid, firm 1 would drop-out. Knows government would then have to raise bid to PC.Key issue: gap from AC1 to AC2Good: Most efficient firm supplying market.Bad: Firm 1 makes some abnormal profit. Why cant government keep lowering bid to P1?1 2 3 4

14、 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Assessing Franchise Bidding:Advantages:Auction mechanism reveals and selects most efficient firm.Regulator needs to know firm costs, Auctioneer simply lowers bid price and firms reveal costs by dropping-out of auction.Lecture 8: Solutions II: Franchise Bidding

15、Economics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Assessing Franchise Bidding:Advantages:Auction mechanism reveals and selects most efficient firm.Regulator needs to know firm costs, Auctioneer simply lowers bid price and firms reveal costs by dropping-out of auction.Lecture 8: S

16、olutions II: Franchise BiddingEconomics of RegulationDisadvantagesMarket needs to have a number of potential, competitive suppliers.Incentive for potential firms to focus on costs, not quality.Does one firm win a once and for all right to provide the market?1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

17、18 19Short-Term Franchise Bidding and Renewal:Over time market may change e.g. new technology, falling input prices cause cost curves to shift downwards.But under once-for-all franchise bidding one firm now owns the market, will make abnormal profits or e X-inefficient.Lecture 8: Solutions II: Franc

18、hise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Short-Term Franchise Bidding and Renewal:Over time market may change e.g. new technology, falling input prices cause cost curves to shift downwards.But under once-for-all franchise bidding one firm now owns the market,

19、 will make abnormal profits or e X-inefficient.Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationWilliamson (1976): Recurrent, Short-Term ContractsKey issue: requires parity between bidders at renewal time.Problem: incumbent firm has already undertaken capital investment. More efficie

20、nt rival could be outbid by incumbent who has already paid fixed costs.1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Franchise Renewal:Incumbent firm AC1, New rival firm AC2. Rival more efficient.PD=ARAC2AC1P1P2AVC1P1*Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationWhen bidding fal

21、ls below P2 new rival has to drop-out of auction.Incumbent only needs to cover variable costs P1*, so wins auction.Incumbent has already paid fixed capital costs, only needs to cover variable costs.1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Incumbent Advantage at Franchise Renewal:Solution: comp

22、ulsory transfer of assets between old and new franchise holder.Lecture 8: Solutions II: Franchise BiddingEconomics of RegulationOf course, counter-problem is incumbent reluctant to fund capital investment if risks losing capital at renewal time.So, also implement compulsory transfer of debt on capit

23、al investments.So franchising isnt straightforward. See vvh Ch. 13 for discussion.Next: Study an example. Look at long-running market.1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Introduction to case study:Franchise bidding is a smart idea, but would it work in practice?Is government intervention

24、really necessary? i.e. is the market under study a natural monopoly? YES/NOKey issue: we need competition at the bidding stage, and, do companies compete only on prices?NATURAL EXPERIMENT: compare franchise bidding with unregulated market e.The case help understanding the weaknesses of franchise bid

25、ding as a solution to the natural monopoly problemLecture 8: Solutions II: Franchise BiddingEconomics of RegulationExample: U.S. Cable Television Market.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Example: U.S. Cable Television Mark

26、et.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Example: U.S. Cable Television Market.1.) How big should a franchise be?The market is a natural monopoly over limited (local) scale of output:Economies of density: unit costs fall with

27、density of provision over geographic area i.e. as number of households within an estate increases.Estimate: increase penetration 40% to 80% lowers unit costs $14 to $8 (approx. -40%)Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Exampl

28、e: U.S. Cable Television Market.1.) How big should a franchise be?The market is a natural monopoly over limited (local) scale of output:Economies of density: unit costs fall with density of provision over geographic area i.e. as number of households within an estate increases.Estimate: increase pene

29、tration 40% to 80% lowers unit costs $14 to $8 (approx. -40%)Economies of distance are small: 10% increase in number of household connected at a fixed penetration rate reduces unit costs only 0.2%Therefore:Small, localised, natural monopoly. In total 11,000 local franchisesLecture 8: Solutions II: F

30、ranchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Example: U.S. Cable Television Market.2.) What are the terms of the franchise?Invite potential suppliers to submit proposals. Detailed. e.g. :Applicants submit bid prices at which they will supply for a fixed perio

31、d, normally 15 years. Price levels are re-negotiable.Municipality accepts bid / invites re-submissions.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Example: U.S. Cable Television Market.2.) What are the terms of the franchise?Invite

32、potential suppliers to submit proposals. Detailed. e.g. :Applicants submit bid prices at which they will supply for a fixed period, normally 15 years. Price levels are re-negotiable.Municipality accepts bid / invites re-submissions.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2

33、 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Some evidence:3.) Does it work well?- 1973 1981 average no. bidders per franchise 5.- 1982 1984 average no. fell to 2.5- suggests falling number of potential new competitors.- plus firms hold more than one franchise CR5=50%Lecture 8: Solutions II: Franchis

34、e BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Some evidence:3.) Does it work well?- 1973 1981 average no. bidders per franchise 5.- 1982 1984 average no. fell to 2.5- suggests falling number of potential new competitors.- plus firms hold more than one franchise CR5=5

35、0%- Prager (1989) found for each additional bidder, price of service offered fell $0.15 per month per subscriber.- Also rise in non-price concessions to local governments after price bid has been finalised (but these come at a cost).Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1

36、2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19How effective is Franchise Bidding How would this market perform under no price controls? Cant tell without an experiment but have one:Cable Communications Policy Act 1984.Market de-regulated i.e. agreed franchise price levels abolished if cable company w

37、as in competition with at least 3 local terrestrial providers.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Competitors of Cable TVLecture 8: Solutions II: Franchise BiddingEconomics of RegulationLocal TV broadcastSatellite TV1 2 3 4

38、5 6 7 8 9 10 11 12 13 14 15 16 17 18 19How effective is Franchise Bidding How would this market perform under no price controls? Cant tell without an experiment but have one:Cable Communications Policy Act 1984.Market de-regulated i.e. agreed franchise price levels abolished if cable company was in

39、competition with at least 3 local terrestrial providers.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Cable operators did not have to honour agreed prices, so gained franchise on exclusive terms.What happened to prices?How effective i

40、s Franchise Bidding (Dec) 1986 1991: 36.5% increase in prices (in real terms).but also a 30% increase in number of channels provided.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19Rubinovitz (1993) calculates quality-adjusted prices, e

41、stimates cable rate 20% higher after de-regulation.How effective is Franchise Bidding (Dec) 1986 1991: 36.5% increase in prices (in real terms).but also a 30% increase in number of channels provided.Lecture 8: Solutions II: Franchise BiddingEconomics of Regulation1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

42、16 17 18 19Rubinovitz (1993) calculates quality-adjusted prices, estimates cable rate 20% higher after de-regulation.1991 Federal Competition Commission re-instated price limits (Cable Act).Began regulating market using CPI X type regulation.reduced rates 17% in real terms, with no loss of franchise.1 2 3 4 5 6 7 8 9 1