Optimal Rate Base Reviews Under Price-Cap Regulation (original) (raw)

2006

Abstract

This paper demonstrates, in a dynamic model of monopoly regulation with price-cap, that a periodical price review may increase productive efficiency. When the firm’s choice of costreducing effort depends on the output supplied, a revision allows the regulator to set more binding prices, thus inducing the monopolist to exert more cost-reducing effort in the future. In a continuous-time setting, we find the optimal timing for the review from a cost-efficiency point of view and the conditions under which, within a given concession period, a single full rate base review improves cost-efficiency, and by this route the optimal number of reviews. This number depends on the length of the concession period in relation to the slope of the demand function and the intensity of the disutility of effort. This result adds both a theoretical argument in favour of the practice of periodical reviews in price-cap regulation and provides regulators with a basis for the calculation of the optimal regula...

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