Awarding monopoly franchises repeatedly: are second-best block-rate tariffs attainable without regulation?

Abstract

Under economies of scale, Demsetz's (1968) proposal of franchise bidding results, at best, in uniform prices approaching average cost. This article questions the accepted belief that the auctioneer always needs to know the market demand function, if the concept is modified so as to allow for bids consisting of block-rate tariffs in order to increase welfare. Given a setting of repeated auctions, the auctioneer can apply a sequential mechanism to evaluate bids, instead of evaluating them in each auction independently. We characterize the conditions under which a second-best block-rate tariff for given thresholds is approached in equilibrium.

Acknowledgements

The author is indebted to Mélisande Cardona, Franz Diboky, Bernd Engelmann, Jörg Finsinger, Günter Knieps, Jürgen Siebel, Robert Wieser, Klaus Zauner, and many other colleagues for their helpful comments and suggestions. Earlier versions were presented at the WIPI Seminar, University of Vienna, 2003, at the Annual Meeting of the Austrian Economic Association in Klagenfurt, 2003, at the 36th Seminar in Transportation Research in Freiburg, 2003, at the Business & Economics Society International Conference in Rhodes, 2004, at the Interdisciplinary Research Seminar of the Department of Business, the Department of Finance, and the Department of Economics, University of Vienna, 2005, at the TILEC Seminar, Tilburg University, 2005, at a Colloquium at the University of Vienna, 2005, and at the Otto Beisheim Graduate School of Management, Vallendar, 2005. The usual caveat applies.

Notes

¹ As the number of bidders approaches infinity, the bidding process attains prices as low as average cost in the limit (Crew and Harstad, 1992).

² A survey of the empirical literature is given by Crocker and Masten (1996).

³ Edlin and Reichelstein (1996) identified conditions under which first-best levels of specific investment can be attained even if contracts are incomplete.

⁴ If r = 1 and p _a > 0, a two-part tariff is given.

⁵ As is well-known, the Ramsey (1927) principles of optimal taxation were applied to second-best pricing of multi-product natural monopolies by Boiteux (1956), Baumol and Bradford (1970) and Rohlfs (1979), among many others.

⁶ The second-bid version is an extension of the sequential mechanism described in Finsinger and Vogelsang (1981). We will see later that, given identical cost functions of the most efficient bidders, it may be advantageous, if there are only few bidders.

⁷ Some models have been developed that consider bidders facing financial constraints, e.g. Che and Gale (1998).

⁸ The convexity of consumer surplus in the absence of income effects is shown by Vogelsang and Finsinger (1979). Of course, their result holds for block-rate tariffs as well, if we take to be aggregate consumer surplus with quasilinear preferences, i.e. consumer surplus without income effects.

⁹ Given the private values according to Assumption 4 (firms), truth telling is a dominant strategy for a bidder in a sealed-bid Vickrey auction anyway (e.g. Wolfstetter, 1999). Notwithstanding, auction models have shown quite generally that a bidder's best response to rivals’ strategies is to submit a bid at which he is indifferent between winning and losing (e.g. Milgrom, 1981; Levin and Harstad, 1986; Bikhchandani and Riley, 1991; Crew and Harstad, 1992).