Using Market Structure to Regulate a Vertically Integrated Monopolist

Posted: 20 Oct 2016

See all articles by Sang Hyup Lee

Sang Hyup Lee

Southeastern Louisiana University

Jonathan H. Hamilton

University of Florida - Warrington College of Business Administration - Department of Economics

Date Written: May 1999

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.

Keywords: Vertically Integrated Monopolist, Cournot, Liberalization

JEL Classification: L5, L96

Suggested Citation

Lee, Sang Hyup and Hamilton, Jonathan H., Using Market Structure to Regulate a Vertically Integrated Monopolist (May 1999). Available at SSRN: https://ssrn.com/abstract=2855968

Sang Hyup Lee (Contact Author)

Southeastern Louisiana University ( email )

SLU-10813
Department of Management & Business Administration
Hammond, LA 70402
United States
985-549-2051 (Phone)
985-549-2881 (Fax)

HOME PAGE: http://scholar.google.com/citations?user=nEbvLHUAAAAJ

Jonathan H. Hamilton

University of Florida - Warrington College of Business Administration - Department of Economics ( email )

Gainesville, FL 32611-7140
United States
352-392-5017 (Phone)
352-392-7860 (Fax)

HOME PAGE: http://people.clas.ufl.edu/hamilton/

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