*1. Judge Williams wrote in United Telecom vs. FCC,
The Commission’s position is based on a fundamental misreading of the relevant
case law. When a statute delegates authority to a federal officer or agency,
subdelegation to a subordinate federal officer or agency is presumptively
permissible absent affirmative evidence of a contrary congressional intent. But
the cases recognize an important distinction between subdelegation to a
subordinate and subdelegation to an outside party.
This distinction is entirely sensible. When an agency delegates authority to its
subordinate, responsibility --and thus accountability--clearly remain with the
federal agency. But when an agency delegates power to outside parties, lines of
accountability may blur, undermining an important democratic check on government
decision-making.
Also, delegation to outside entities increases the risk that these parties will
not share the agency’s ‘‘national vision and perspective.’’
In short, subdelegation to outside entities aggravates the risk of policy drift
inherent in any principal-agent relationship.
The fact that the subdelegation in this case is to state commissions rather than
private organizations does not alter the analysis.
The FCC acknowledges that § 251(d)(2) instructs ‘‘the Commission’’ to
‘‘determine[ ]’’ which network elements shall be made available to CLECs on an
unbundled basis. But it claims that agencies have the presumptive power to
subdelegate to state commissions, so long as the statute authorizing agency
action refrains from foreclosing such a power.
(a) (10 points) Who is the principal and who is the agent here?
Answer. The FCC is the principal and the state agency is the agent.
(b) (10 points) What does Judge Williams mean when says delegation has a problem concerning ‘‘national vision and perspective’’?
Answer. The state agency cares about the well-being of the state, not of the nation. Thus, it will choose regulations that help the state even if they hurt the nation.
(c) (10 points) Explain how this illustrates government failure.
Answer. The FCC wished to rid itself of work and responsibility, so it tried to delegate the work to state agencies. The result was that when an unpopular regulation was issued, the FCC could blame the state agencies, while the state agencies could blame the FCC for mandating regulations. This divided responsibility meant that the voters would not know who was to blame.
2. Consider the following hypothetical story. A state was settled in the 1840's, and by the 1860's was served by just one railroad. The population of the state stopped growing for many years. The railroad was highly profitable, but no other railroads entered the market. In 1890, a Rate Commission was set up that required the railroad to set particular prices. The state's population started climbing again. In 1930, a second railroad requested permission to enter the market and lay its own tracks, but the Commission refused. The Commission started regulating trucking as well as railroads, since trucks started to compete with railroads. In 1980, the Commission was eliminated by the state legislature and railroads and trucks became unregulated. Two new railroads immediately were started, and railroad rates and trucking rates both fell.
*(a) (10 points) How does this story illustrate the concept of natural monopoly? Illustrate with a graph showing cost and demand curves.
Answer. Initially, the market was only big enough for one railroad to survive. That is because demand was small and the fixed cost of a railroad is high compared to the marginal cost. Although the one railroad was profitable, if another railroad had entered and they had competed price down to marginal cost, both railroads would have lost money. Thus, no entry occurred despite the monopoly profits.
(b) (10 points) Was there a good reason to establish a Rate Commission? Explain.
Answer. Yes. In a natural monopoly, the unregulated price will be at the monopoly level, with all the standard defects of monopoly-- inefficiently low output, higher costs, rent-seeking, and so forth. The Rate Commission could require the price to be lower.
(c) (10 points) How does this story illustrate the idea of "regulatory capture"?
Answer. After some time, demand increased enough (with population and income growth) that the industry was no longer a natural monopoly. The Commission forbade entry, though. There is no consumer protection justification for that; it must have been to protect the incumbent railroad. Thus, the incumbent had "captured" the Commission, and was using it to keep prices high, the opposite of the COmmission's original intent. Restrictions on trucking are similar: the Commission wanted to suppress competition that would hurt the railroad's profits.
(d) (10 points) Come up with an explanation for why the Rate Commission might have come into existence and then why it was eliminated.
Answer. One good story is that the Commission came into existence because of complaints from railroad users who didn't like the monopoly profits. They were hurt by high prices more than the railroad was helped, so they lobbied more and won the political battle. As time passed, however, the users did not pay close attention, and the railroad came to control the Commission. In particular, users did not notice that the growth of the market and the invention of the truck meant that entry could actually occur and *reduce* prices. Eventually, though, the inefficiency became so great that pressure built to reform the system by abolishing the Commission. The profits of the incumbent railroad were just too low relative to the potential gains to users and profits to new entrants. Thus, the political balance shifted nd the Commission was abolished.
(e) (10 points) Show how cost curves and demand curves for transportation shifted from 1880 to 1980.
Answer. 
Demand shifted out, so that even with the old cost curves for railroads, transportation would no longer be a natural monopoly. In addition, since trucks have low fixed costs and marginal costs, "transportation" generally went from being a natural monopoly even for low quantities to being competitive even with the old 1880 demand curve.
3. (20 points) Graph the price of electricity in Kokomo as a function of output (see the clipping below).
Answer. 
Answer. 
(20 points) Why might a price structure like this be more efficient than a constant flat rate? Assume that the marginal cost is constant.
Answer. For full efficiency, the price should be equal to the marginal cost. If it is higher, then people will refrain from buying an extra therm even if the benefit to them is higher than the cost of production. Thus, bringing the per- unit price closer to marginal cost increases efficiency. To make up for the revenue loss, however, the company needs to have the 6.50 monthly fixed price.
I was particularly pleased that many students seemed to have a "gut-level" understanding of this, answering the question in their own words (and correctly) rather than just using economic phrases. Economic phrases are fine, but a teacher always wonders whether the student really understand what he is saying or not.
4. The attached first seven pages of "Initial Brief of the New York State Consumer Protection Board" is an argument to the New York Public Service Commission for why Hudson Gas and Electric's rate increase should be less than the company proposes.
(a) (10 points) A rate case involves discussion of both the cost and revenue sides of a company's operations. Which of Hudson's cost claims and proposals does the Consumer Protection Board attack?
Answer. 1. Hudson wants an 11.5% return on equity; the CPB thinks 10.2% is enough. 2. The CPB objects to Hudson's storm expenses and distribution system as too costly. 3. The CPB thinks Hudson overestimated the amount of gas plant in service (p. 4). 4. The CPB would reduce the electric plant in service and reduce depreciation expenses and reserves (p. 5). 5. The CPB opposes Hudson's "stranded benefits" proposal, its "projected electric net deferrals", and its Enhanced Line Clearance Program. 6. The CPB would reduce the projected cost of the ROW and of the direct labor costs.
To get full credit, you did not need to list all of these, but you had to mention the return on equity and some of the items from pages 4 and 5.
(b) (10 points) Which of Hudson's revenue claims and proposals does the Consumer Protection Board attack?
Answer. The portion of the brief you have only discusses revenue claims on page 3, where the CPB merely says it "supports the vast majority of Staff's revenue requirement recommendations". This part of the brief is more specific on revenue proposals; on page 3-4 it says the CPB opposes increases in the gas and the electric "customer charges" and it opposes Hudson's proposal to eliminate time of use rates.
The word "revenue" is used in sentences about, for example, the fossil fuel plant auction, but those sentences do not make revenue claims or proposals, except in the sense that any cost proposal is a revenue proposal because Hudson says it needs higher revenue to cover the claimed costs. I gave partial credit for references to such sentences anyway.
The issue of the rate of return on equity is a cost issue, not a revenue issue, because it is about the company's cost of capital, not about pricing schemes or the location of the demand curve.
(c) (10 points) The brief claims that Hudson's estimate of its cost of capital is excessive. If this is true, but the Commission is fooled into believing it, what inefficient incentive does this give Hudson?
Answer. If Hudson is given too high a rate of return on its capital, the Averch-Johnson effect will be induced. Hudson will have an incentive to expand its rate base, because its return on capital will be greater than its cost of capital.
(d) (10 points) Hudson has proposed eliminating time-of-use rates-- prices for electricity which vary over the course of the day. Why might eliminating these rates be a bad idea?
Answer. Making rates uniform across time would mean that the company would be charging the same price when marginal costs are low (night and weekends, when demand is lower and production methods such as nuclear power can be used) and when marginal costs are high (the working day, when demand is higher and more expensive production methods such as natural gas must be used). Some customers would be buying electricity even though their benefit was less than the marginal cost, so the gains from trade were negative.
Kokomo Gas and Fuel Company (IURC No. G-13) First Revised Sheet No. 10
Rate No. 10 Rate for Residential Non-Space Heating Gas Service Kokomo,
Indiana and Suburban Towns, Communities and Rural Areas
Availability
The following rates are available to any customer for residential service whose
premises are located adjacent to the distribution mains of the Company suitable
for this service.
Rate
For billing purposes, it is assumed that 100 cubic feet contains 100,000 Btu, or
1 Therm
First 30 Therms per month: $0.58000 per Therm.
All use over 30 Therms per month: $0.51832 per Therm.
See "Rate Tracking Factor" below.
Rate Tracking Factor
( ) Indicates negative number
This rate is subject to adjustment for fluctuation in the cost of purchased gas
and the cost of foreign storage. (See Appendix A .)
Customer Charge
$6.50 per bill per month.
The customer charge shall be the monthly minimum bill.
Late Payment Charge and Application on Delinquent Bills
Bills shall be rendered and due monthly. If paid within seventeen (17) days from
the mailing date thereof, or the due date as stated in the bill, the net bill
shall be the amount to be paid. If not paid within the due date thereof as
stated in the bill, the gross bill, which includes the collection charge of
three percent (3%) of the net bill, shall be the amount to be paid. When the due
date falls on Saturday, Sunday or any legal holiday, the first business day
thereafter shall be added to the seventeen- (17-) day period.
Reconnection Charge
When the service is turned off for non-payment of bill, or whenever, for any
reason beyond the control of the Company, a reestablishment of service is
required by any one customer, a charge of ten dollars ($10.00) or the total
customer charges for the period gas service was discontinued, whichever is
larger, will be made by the Company to cover a part of the cost of
discontinuance and reestablishment of service.
Nonsufficient Funds Checks
A charge will be made to reimburse the Company for its cost in handling a
Customer's check returned by any bank for nonsufficient funds, which charge
shall be eighteen dollars ($18.00).
Rules
Service hereunder shall be subject to Company's Rules and Regulations and the
Rules and Standards of Service for Gas Public Utilities prescribed by the
Indiana Utility Regulatory Commission from time to time.
Effective Date August 28, 2002