Let's assume that cable TV is a local monopoly (there is only one supplier in a given town). If you asked most people what's wrong with cable TV being a monopoly, they would probably respond that monopolies charge "too much money." It is true, by selling less output than society wants them to, a monopolist is able to obtain a higher price for its goods. But it would be a mistake to focus on this part of the problem.² The real problem with cable TV being a monopoly is that it results in too few cable TV services being supplied to consumers.

In evaluating the effect of cable TV regulation on the happiness of society, the trick is to keep one's eye on the ball. Once again, that means concentrating on how the rate regulation is likely to affect the allocation of resources in the economy. Can this government intervention increase society's happiness? Following the arguments of the last chapter, we know the answer is yes. But to be effective, the intervention must cause the cable TV company to provide more cable services.

For example, suppose--prior to government intervention--a cable TV company had thought about attracting new subscribers by lowering the cost of its basic package from $25 to $20 a month. Providing cable TV to additional subscribers would require the firm to transfer resources away from consumers elsewhere in the economy. What kind of resources? Office personnel would be needed to keep track of subscribers' accounts. Service representatives would have to be available to handle customers' problems. These represent withdrawals of labor from other activities. If adding extra customers resulted in an increase in labor costs of approximately $15 per customer, then that means that the extra labor required to service an additional subscriber would produce approximately $15 of happiness at some other activity.

Weighed against this cost is the extra revenue the firm would receive. Suppose the firm calculated that the extra revenue from selling more cable subscriptions would not compensate it for the cost of servicing those subscriptions. While the new subscribers would be paying $20 for their cable service, the cable TV company, in order to attract these new subscribers, would have to lower prices for everybody. Thus, the extra revenues that the firm would gain by reaching out to these new customers would be less than $20 per customer. How much less? Let's say that the extra revenues from an additional customer worked out to about $5 per new subscriber. Clearly, given these numbers, the cable TV company would not have a financial incentive to make this resource transfer. This is illustrated for a representative customer on the Before side in the Profit Table below. The revenue, cost, and profit lines do not represent totals, but rather the revenue, cost, and profit that occurs from the production of the extra cable only.

Everything is different when the government intervenes in the market. Suppose the Cable Commission imposes a price ceiling on the company, forcing it to lower its rates from $25 to $20. As discussed in the last chapter, the effect of this policy is to increase the firm's profits if it increases production, from -$10 to $5. Now the cable company finds that it is better off dropping its rates and providing more cable services. And that's great. Because the reality is, as this representative account shows, servicing another customer takes resources worth $15 elsewhere in the economy and directs them to a cable TV customer who gets $20 of happiness. And while the company's customers rejoice and its shareholders weep, the bottom line is that society is a little bit happier because of the market intervention of the good folks at the Cable Commission.

The previous discussion has demonstrated that ordering cable companies to cut their prices can make society better off. But will it? Now that's an entirely different question. For example, the government must be careful that it's intervention doesn't decrease the amount of output the monopolist produces. How can that be, you ask? If the cable TV company is forced to charge a lower price, and that lower price induces more consumers to subscribe to cable TV service, won't that necessarily cause the quantity of cable TV services to increase? Consider the statement by Decker Anstrom, "This will seriously disable cable companies' ability to invest money in future technology."

Suppose you were the owner of a cable TV company. What would be your incentive for adopting new technology (e.g., better transmission equipment) or making improvements in your service (e.g., more attractive bundling of channels)? Higher profits. But suppose you also knew that the Cable Commission was always looking over your accountant's shoulder, making sure that you didn't make "too much" profit. How would that affect your incentive to make investments in future technology and improvements?

It's a "heads you lose, tails you draw" proposition. If the new technology is a bust, or the improvements aren't a big hit with customers, you've entailed extra expenses with no rewards. You lose. But suppose your consumers love the new changes and cable demand increases dramatically. Do you get to reap the rewards? Not necessarily. The Cable Commission stands poised on the industry sidelines, ready to jump onto the playing field and take away your profits. If they appropriate your profits, you're back where you started from. You draw. Who could blame you for asking, why risk it? Why not stay with the safe, old technology and get your normal, Cable Commission-approved profits? No sweat, no pain.

When this happens, rate regulation can have the effect of lowering society's happiness by causing the monopolist to produce less output in the future. Sure, the cable TV company may have more customers paying lower rates. But the quality of that service will be adversely impacted by the negative incentives to invest which are a byproduct of rate regulation. Measured in quality-adjusted units, output may actually fall. Too few resources will end up being transferred to the cable TV industry. Government intervention will have served to exacerbate the monopoly problem.

And this is only one possibility. The same lack of incentives that apply to investing in new technology also apply to lowering costs. Why should the cable company reduce its costs when regulators will take away any increase in profits by forcing the firm to lower rates still further? If rate regulation causes the company not to work so hard in reducing costs, that also decreases society's happiness. Resources aren't being released as they would be in the absence of regulation. That means lower happiness for consumers elsewhere in the economy.

Being a regulator is a bit like walking a tightrope...blindfolded. The regulator knows his job is to get the monopolist to produce more output. But how much more? Here's the rub...HE HAS NO IDEA. In real life, there are no tables like J.D.'s hypothetical revenue table from the previous chapter. So the regulator takes a stab in the dark. He sets a new, lower price. More output gets produced (at least in the short run). But the second he intervenes, everything changes. The incentives of the monopolist to introduce new technology, improve service, and reduce costs all change dramatically. Now the regulator can't look at the firm's actual revenues and costs. He has to imagine what they would be in the absence of his intervention. He has to imagine a world without regulation, and calculate the happiness-maximizing level of output in THAT world. And then he has to figure out a way to manipulate the firm so it produces that level of output in this, the regulated world.

To know whether he has done his job successfully, the regulator has to see how the world would have existed in the absence of his intervention. Since that world is forever unseen--leaving the regulator blindfolded, if you will--he can only inch along on the tightrope, hoping he is increasing--and not decreasing--society's happiness.

Actually, we exaggerate when we say that the unregulated world is forever unseen. Every now and then, a window into that world opens up. It happens whenever the government decides to deregulate a previously regulated industry. For example, in the 1980's the airline, trucking, and telephone (long-distance) industries were all deregulated. The original argument for regulating these industries was that each of these represented a monopoly. Hence government intervention was called upon to increase society's happiness. If government regulation of these industries had been successful, then that regulation should have persuaded these industries to produce more. Thus, deregulation should have resulted in these industries producing less output than when they were regulated. What was the actual result? In each case, industry output increased dramatically under deregulation. Our evaluation of regulation in these cases can be clear and unequivocal: government intervention exacerbated the monopoly problem and made things worse, lowering society's happiness.

We don't give these examples to say that regulation of monopolies will always produce lower social happiness. Nor to say that regulators are bungling bureaucrats who should know better. We give these examples to point out the daunting task facing a regulator. Just because a monopoly problem exists does not mean that government intervention will make things better. It could make things worse.

So what should society do? The best economics can do is to point out the right questions to ask. First, just HOW SERIOUS IS THIS MONOPOLY PROBLEM? Is the monopolist producing a lot less than the amount of output that would maximize society's happiness? A monopolist will only produce a lot less than the social ideal if it can substantially jack up its price by restricting the amount it sells (recall J.D. Rockefeller's revenue table from the previous chapter). While it might be true that the local cable company is the only cable game in town, even the cable TV company has competitors. There's ABC, NBC, CBS, and Fox, all of which do not require cable. There's Blockbuster Video and the local video rental stores in town. Heck, even grocery stores rent videos nowadays. ("Yes, Ma'am. We do have the new release of Die Hard VII. You'll find it right next to the frozen artichokes in the Produce section.") In addition, there are all sorts of satellite dish and on-line computer technologies that stand ready to steal consumers away from cable TV companies should those companies raise their prices too high. The ability of a monopolist to charge higher prices is restricted by the willingness of consumers to pay those higher prices. To the extent reasonably close alternatives exist, the monopolist will not be able to substantially increase its price, and there will not be a serious monopoly problem.

The second question which needs to be asked is, CAN THE GOVERNMENT REGULATOR BE REASONABLY CONFIDENT THAT HE CAN INDUCE THE MONOPOLIST TO PRODUCE MORE OUTPUT? AND CAN HE DO SO WITHOUT SUBSTANTIALLY REDUCING THE INCENTIVES OF THE MONOPOLIST TO REDUCE COSTS? A necessary condition for regulation to increase society's happiness is that one be able to answer these questions affirmatively.

To be sure, these are incredibly difficult questions to answer. Reasonable people will disagree. One never knows--indeed, cannot know--whether their own answers to these questions are correct. That doesn't mean that society should never regulate. It simply means that society should be mindful that the presence of a market imperfection does not guarantee that government intervention will make things better. Once we leave the unregulated world of market prices and profit-maximizing firms, we enter a world of darkness--with no guarantee that the steps we take will move us closer to maximizing society's happiness.