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Journal of Regulatory Economics

, Volume 15, Issue 3, pp 223–248 | Cite as

Using Market Structure to Regulate a Vertically Integrated Monopolist

  • Sang Hyup Lee
  • Jonathan H. Hamilton
Article

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

Market Structure Welfare Gain Optimal Contract Vertical Separation Free Entry 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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Copyright information

© Kluwer Academic Publishers 1999

Authors and Affiliations

  • Sang Hyup Lee
    • 1
  • Jonathan H. Hamilton
    • 1
  1. 1.University of Florida Department of EconomicsGainesville

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