chapter  3
60 Pages

Competition issues

There is general agreement on the need for regulation in natural monopoly industries. These are industries in which the ratio of fixed (inescapable) to variable (escapable) cost is often very high. The fixed costs are often associated with heavy infrastructure investment, which often generates some enormous economies of scale, with average costs falling as output expands. Telecommunications, gas and electricity distribution, and water supply are often cited as examples of natural monopolies. If there were several firms supplying a given local area, this would result in multiplication of cables, transformers, pipelines, and so on. Consequently it is much more efficient if local monopoly rights are granted to just one firm. But to prevent this firm exploiting its monopoly position, regulation is required to restrain prices. This is why the UK government, having decided to privatize telecommunications, power, and water utilities, also decided to impose upon them price caps related to the rate of general price inflation. It is also the reason why similar public utilities in the US are subject to rate-ofreturn constraints in their pricing.