Public utilities are firms or industries regulated by government agencies (usually public-utility commissions). Public utilities are generally private companies given exclusive rights to provide a service in a particular area. In effect, a public utility is a government-created and regulated MONOPOLY. There is a long history of government-created monopolies. The Commons House of Assembly, in prerevolutionary South Carolina, granted monopolies to local ferry operators between coastal islands. The House named the recipient of the monopoly and dictated the fare that could be charged. Between Beaufort, South Carolina, and Lady’s Island, the ferry operator was allowed to charge 7½ shillings for a man and his horse. As historian Larry Rowland and coauthors report, the ferry operator had a complaint: “What he desired was relief from the many disputes and inconveniences that arise from want of a law to fix . . . rates and other regulations.” Similarly, in 1843 Oregon passed laws regulating granaries in the public interest. There are many public utilities, ranging from telephone and electric services to pay-phone providers, local water companies, local cable companies, and even cotton gins. Public utilities are created based on the concept of natural monopolies, industries and markets where ECONOMIES OF SCALE exist over a wide range of output and cost per unit declines as PRODUCTION is increased. Industries where there are significant start-up or fixed COSTS and low additional or marginal costs when output is increased are likely to experience economies of scale. For example, in a local telephone service, the cost of creating a wire and connection system is significant, but the extra cost of providing local service to another customer is minimal. By spreading the fixed costs of creating the communication system over a larger number of consumers, the average cost of service declines. One large telephone-service provider can provide local service at a lower cost than many small companies could. It would be a waste of RESOURCES and inefficient to have multiple firms providing local telephone service. This was the case in the early 20th century, when business owners often subscribed to five or more telephone services, each a separate phone system, in order to communicate with customers and other businesses. In such a situation, it is natural to create a monopoly. A monopoly is a market with only one producer and no close substitutes. Without regulation, monopolists will operate at a level that maximizes PROFITs. This usually results in higher prices and lower levels of output than if the market was competitive. In situations where natural monopolies exist for basic consumer goods, government frequently creates public utilities. Because such SERVICES are the only source of what most consumers consider necessity goods, government regulation is necessary, since otherwise monopolists could charge very high prices and consumers would have no recourse. Every state has a public-utility commission (PUC, also called a public-service commission) regulating electricity, natural gas, railroads, water, and telephone services. These commissions usually assert their mission is to “provide, safe, reliable service at reasonable rates.” “Reasonable rates” can be interpreted in many ways. Utilities are allowed a “fair” return, usually calculated as a percentage return to their INVESTMENTs (ROI). For example, if an electric utility company invests $100 million, and the utility commission allows them an 8-percent return, the company would earn an $8 million PROFIT annually over the life of the investment. With this type of regulation, the more the utility invests, the greater their absolute level of profit (though the percentage return would remain constant). Fair-return pricing encourages utility spending rather than cost controls. Most utility commissions set utility prices equal to the average cost (including profit) of providing the product or service. With this method, total revenue will just cover the utility’s total cost. PUCs also allow pricing such that the average price equals the average cost. Using this method, the utility charges different prices for different quantities or levels of service, but overall, total revenue will equal total cost. With changing technologies, public-utility commissions have often deregulated and even reregulated certain industries. For example, AT&T; was created in the early 1900s as a federally mandated monopoly for long-distance telephone service. The company argued to Congress that only with a monopoly could they safely invest in national telephone service using one technology. (At the time there were hundreds of small, local telephone companies, often using different, incompatible technology.) In 1984 Congress ended AT&T;’s monopoly, allowing Sprint and MCI to compete in long-distance service using new technology (satellites and microwave systems) that bypassed AT&T;’s long-line system. The regional telephone systems, known as the Baby Bells, continue to operate as regulated monopolies. Before 1984, AT&T;’s profits from long-distance service subsidized local service. After the end of regulation, long-distance prices fell while local-service prices rose. The 1996 Telecommunications Reform Act was supposed to increase COMPETITION by allowing Baby Bells to offer long-distance service and let the long-distance companies enter local-service markets. While consumers often benefit when monopoly markets are made more competitive, monopolists, including public utilities, usually resist opening their markets to new competitors. To date, local telephone-service utilities have resisted DEREGULATION, limiting the impact of the reform measures. The most widely reported attempt at utility deregulation was the 1990s attempt to deregulate electricity prices in California. The California public-utility commission, after years of study and contentious debate, allowed electricity producers to compete and charge market prices. Prices to consumers were still regulated, and charges for distribution through the electrical grid were also regulated. The major utility companies in California began buying power from independent producers for delivery to their customers. In the late 1990s, a combination of increased DEMAND, shutdowns at power plants, and structural problems with the distribution grid lead to a power shortage and huge increases in the PRODUCTION price. There were also charges that major electrical power brokers manipulated the producer market. With retail prices regulated but the cost of power skyrocketing, mandatory rolling blackouts were instituted, and California electrical utilities lost billions of dollars. Members of state public-utility commission boards are usually appointed by the governor subject to the approval of the state senate. Frequently consumer groups have questioned the objectivity of PUCs, complaining that the commissions often have too-cozy relationships with the utilities they have jurisdiction over. Most state consumeradvocate offices scrutinize the proceedings of PUCs to ensure the interests of the general public are represented in their decisions.
See also PROFIT MAXIMIZATION.