Infrastructure & Utility Economics: the economics of sunk costs – the e-book


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This book explains the economics of sunk costs: the dynamic sequence of investor and management decisions that determines the evolution of market structures in industries such as electricity, gas, water, wastewater, rail, road and broadband telecoms. These industries are natural monopolies, but professionals have known for decades that the classic explanation found in most economics textbooks is wrong: infrastructure and utility economics is all about high sunk costs, not high fixed costs. Baumol, Panzar and Willig noted this in 1982, but because their initially promising contestability model could not handle evolution of an industry through time, or new technologies, they concentrated on end-states and the unhelpful cul-de-sac of subadditivity. This textbook is the first to propose a coherent general theory of the economics of sunk costs as they evolve through time: a sequence model of successive decisions and sunk costs is used to define asymmetric paths in time or space, which inevitably leads to monopoly once one entrant is committed. Whether this monopoly endures to the end-state (stasis in the business environment) depends on subsequent entrants’ resources and perceptions, but is very likely for electricity, gas, water and rail, given the anticipated huge sunk costs of entry and the difficulty of subsequent entrants being able to differentiate their service.

The second edition of this seminal text sets out the general economics of sunk costs, particularly the economics of large sunk costs and the sequence of decisions that makes up the launching of a piece of physical infrastructure which then becomes a national or local utility. The general model, simply and graphically expounded in Chapter 3,  first discusses alternative definitions of sunk costs, and then defines them properly – as asymmetries in technology, time or space. It then develops a general sequence model to explain exactly how geographically and technologically unique sunk costs are massive entry barriers that inevitably create local monopolies, parallel monopolies, or national monopolies. Using simplified systems models it explores the circumstances under which second and subsequent entries can rationally occur, leading to a theory which accurately predicts why electricity, gas, water, wastewater and rail are nearly always monopolies, but broadband landlines, bus companies and postal services may be oligopolies, duopolies or monopolies. The general theory handles technological and market change very simply, dispensing with all notions of fixed revenue and cost curves, and is generally applicable to any industry in any circumstance, but is particularly useful when sunk costs are significant – as in the modern automobile, aircraft-making, or mobile phone industries (Chapter 4).

Having introduced students to infrastructure economics, the economics of sunk costs, the basics of the utility industries (Chapter 1), and to the general theories of utility evolution, the book explains the techniques that are actually used by practitioners to analyse and advise policymakers, in simple language suitable for anyone with an understanding of basic economics. It explains how to calculate forward-looking long run marginal costs in a time-series sense, how to measure network outputs properly, and how to compare the efficiency of different networks in the same industry fairly (not as obvious as one might think). In the course of this “easy and informative” exposition the limitations of neoclassical models are exposed, and more general tools are gently explained, using 148 colour diagrams and a minimum of algebra.

This is the only textbook to explain the basic stages of infrastructure economics and of each heavy utility (the value chains and the nature of energy demand, water demand, wastewater demand and transport demand), define sunk costs properly, propose a coherent theory of sunk costs to explain all market structures, and then use this theory a) to develop standard professional utility economist techniques such as measuring the long run marginal costs of utilities, determining utility outputs and techniques for measuring the efficiency of individual utilities, and b) to apply this theory to recent global examples where utilities around the world have been restructured and often privatised.

The full contents of the book are described in the Contents pdf file which can be downloaded immediately. The e-book is available in .epub (iBooks etc.) or .mobi (Kindle etc.) formats, and individual chapters are available in both formats. Chapters 14 explaining all the general basic concepts are FREE, while Chapters 5-13 range in price from $5 to $15 (£4 to £12). Hard copies of the book are available for dispatch from the UK at a price of £60 or $75 plus P&P.

Publication date: 10 July 2017¦ ISBN-13: 978-0-9576990-1-4 ¦Edition: Second

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