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Using Market Structure to Regulate a Vertically Integrated Monopolist

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Author Info
Lee, Sang Hyup
Hamilton, Jonathan H

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Abstract

A natural monopolist whose cost is private information produces a good which is combined with another good that can be produced by the monopolist or by other firms. The agency that regulates the monopolist can impose any of several different market structures in the industry: integrated monopoly, vertical separation with free entry downstream, or liberalization downstream (both integrated and independent production). When several firms produce downstream, a Cournot quantity-setting game with free entry determines the market price. We derive the optimal contracts to offer the monopolist under all three market structures and examine the influence of downstream cost differences on access prices. We then study the optimal regulatory policy where the regulator can condition the downstream market structure on the monopolist's cost report to the regulator. The optimal regulatory policy awards a monopoly to a low-cost upstream firm, but requires free entry downstream if the monopolist reports high upstream costs. Thus, the choice of market structure is an additional tool to limit rent extraction by the monopolist. Simulation analysis reveals the possibility of significant welfare gains from this additional regulatory tool. Copyright 1999 by Kluwer Academic Publishers

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Publisher Info
Article provided by Springer in its journal Journal of Regulatory Economics.

Volume (Year): 15 (1999)
Issue (Month): 3 (May)
Pages: 223-48
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Handle: RePEc:kap:regeco:v:15:y:1999:i:3:p:223-48

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Web page: http://www.springerlink.com/link.asp?id=100298

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  1. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2002. "How to Auction an Essential Facility When Underhand Integration is Possible," Working Papers 839, Economic Growth Center, Yale University. [Downloadable!]
    Other versions:
  2. David Mandy & David E. M. Sappington, 2004. "Incentives for Sabotage in Vertically Related Industries," Working Papers 0404, Department of Economics, University of Missouri, revised 16 Dec 2004. [Downloadable!]
    Other versions:
  3. Armstrong, Mark, 2001. "The theory of access pricing and interconnection," MPRA Paper 15608, University Library of Munich, Germany. [Downloadable!]
  4. Stefan Buehler, 2001. "How to Regulate Vertical Market Structure in Network Industries," Working Papers 0102, University of Zurich, Socioeconomic Institute. [Downloadable!]
  5. Martimort, David & De Donder, Philippe & De Villemeur, Étienne, 2003. "An Incomplete Contract Perspective on Public Good Provision," IDEI Working Papers 212, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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