economic regulation and deregulation in the u.s.a.: airlines, electric utilities professor dr....
Post on 20-Dec-2015
223 views
TRANSCRIPT
Economic Regulation and Deregulation in the U.S.A.: Airlines, Electric Utilities
Professor Dr. Christopher Brown
Outline “Old regime” economic regulation of the airline
industry Airline deregulation: Assessing the outcome “Old regime” economic regulation of electric
utilities. Electric utility deregulation: Assessing the
outcome
Economics of the Airline Industry•High fixed cost
•Low (negligible) marginal cost of serving passengers
•“Load factors” are critical
•Long-haul economies
•Powerful unions of pilots and machinists
•Sophisticated systems of price discrimination or “yield management”
•Control of gates and take-off and landing rights at airports by large carriers blockades entry of new carriers at major airports (LAX, Chicago, Atlanta, for example).
Passenger Miles (PMs) = Passengers Miles Traveled
$/PM
PMs0
Cost per passenger mile
Flight profitability partly depends on:
•Number of passengers (load factor)
•Distance of flight
Civil Aeronautics Board (CAB)1938 Civil Aeronautics Act
The Civil Aeronautics Board (CAB) created to: (1) promote airline safety; (2) to insure the industry operates in an economically sound fashion; and (3) to allow for the adaptation of the airline system to the commercial, postal, and defense needs of the country.
The CAB determined that its primary objective should be to insure that “economical” air service would be widely
available.
Airline Regulation under the CAB
Fares set by a formula developed by the CAB that raised fares substantially above costs on medium and long haul trips and below costs for short haul trips.
Carriers could not enter or exit specific routes. High profits earned on “prime” routes subsidized
losses sustained on undesirable routes.
Chicago
Dallas
Omaha
Fargo
High load factor, long distance
Low load factor, short distance
Deregulation
For an overview see Clifford Winston, "Economic Deregulation: Days of Reckoning for Microeconomists," Journal of Economic Literature, September 1993:1263-1289.
The 1971-96 is called the "era of deregulation" because of the major deregulatory initiatives passed—
e.g., the abolition of fixed brokerage fees by the SEC in
1975, the Motor Carrier Reform Act
of 1980, and the Telecommunications Act of 1996.
If economic regulation can improve social welfare, why deregulate?
•Professor Stigler’s “capture theory” of regulation
•Professor Peltzman’s “political theory” of regulation
•The Averch-Johnson effect
The Airline Deregulation Act of 1978
•Since 1982 entry has been granted on all interstate routes to carriers that are "fit, willing, and able."
•All restrictions on fares lifted in 1983.
• The CAB is defunct.
DallasLubbock
OK City
DenverCol. Springs
Laramie
Hub and Spoke system
Effects of the Hub and Spoke System
•Cheap fares on flights between hub airports (Dallas to Denver, Atlanta to Chicago, New York to LA).
•Expensive fares for service between (non-hub) cities linked to different hub airports.
•“Window of opportunity” for the “no frills” discount carriers such as Southwest Airlines, AirTran, and US West.
Assessing Airline DeregulationCriterion
Overall fares Very good
Dispersion of fares (price discrimination)
Bad
Travel time Mixed results
Service frequency Good
Load factors Good
Safety No difference
Service quality Bad
Travel restrictions Bad
Working conditions Bad
Morrison and Winston estimate
benefits (lower fares) from airline
deregulation exceed $20 billion per year.
Peltzman, S. and Winston, C., editors. Deregulation of Network Industries: What’s Next? (AEI-Brookings Joint Center for Regulatory Studies, 2000), p. 2
Airline ticket pricingConsider United Airlines Flight 815 from Chicago to LA on October
31, 19971
•There were 27 different one-way fares, ranging from $1,248 for a first class ticket purchased the day of the flight to $87 for an advance purchase coach ticket.
•Some travelers cashed in frequent flier miles.
•Some qualified for senior citizen discounts.
•Some passengers traveled on restricted tickets that required Saturday stayovers.1”So, How much did you pay for your ticket,” New York Times, April 12, 1998
Airline Bankruptcies(partial list)
•American Airlines
•United Airlines
•U.S. Air
•National Airlines
•Midway Airlines
•Pan American Airlines
•Trans World Airlines
•People’s Express
•Eastern Airlines
Structure of the Electric Utility Industry
GenerationDistributionTransmission
Features of “Old Style” Utility Regulation
Vertically-integrated power companies enjoy regional monopolies but are subject to regulation by state commissions.
State commissions use the “revenue requirement” model to establish electricity rates.
Regulated utilities subject to minimum capacity requirements.
Revenue Requirement Model
ErRBRR )(
RR is the “revenue requirement”
RB is the rate base—an estimate of the value of owners’ investment in the regulated firm.
r is the “allowed rate of return” to owners’ investment.
E is expenses (fuel, wages, etc.)
Electric deregulation is really about the vertical separation of the three
stages of production—or the creation of a multi-
market industry.
Deregulation California Style
Formerly integrated utility giants (Cal. Edison, Pacific Gas & Electric) retain distribution monopoly but required to sell off generating and transmission assets.
Utility companies get $28 billion in “stranded costs” financed by a “competitive transition fee.”
Distribution monopolists subject to rate regulation by California Public Service Commission
Distribution companies must purchase power “spot” on the “power exchange”—no forward contracts allowed.
Independent system operator (ISO) created to manage transmission.
Generation transformed into a competitive industry
Independent System Operator (ISO)
•Operates the transmission grid
•Power generators have access to the grid on equal terms.
•Subject to regulation by California Public Service Commission and FERC
1994 10.23
1995 9.94
1996 9.98
1997 10.06
1998 10.09
1999 10.11
2000 10.42
2001 13.30
2002 13.41
2003 13.92
First year under new regime
Average Retail Electricity Prices in California (cents per kilowatt hour)
Source: California Energy Commission
Energy “speculators” (several employed by
Enron) took advantage of these unique aspects
of electricity and “rigged” the wholesale
market.Important aspects of electricity
•Inelastic demand
•Non-storable
•Capacity limits on transmission