Price cap regulation of a dominant firm facing competition |
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Authors: | Kevin M Currier |
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Institution: | (1) Department of Economics and Legal Studies in Business, Spears School of Business, Oklahoma State University, Stillwater, OK 74078, USA |
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Abstract: | Price cap regulation is typically applied to natural monopolies operating with subadditive costs. Price caps are known to
provide superior incentives for the regulated monopoly to pursue cost reduction and, in a multiservice/product context, undertake
welfare enhancing price discrimination. It is well known that capping a Laspeyres index of the firm’s prices induces the monopoly
to charge socially optimal “Ramsey” prices in the long run. This paper examines the suitability of the Laspeyres form of regulation
when the regulated firm faces competition in the market for one of its services (outputs). We present the appropriately modified
Ramsey pricing rule for the regulated dominant firm and demonstrate that capping a Laspeyres index of the dominant firm’s
prices leads to prices that satisfy this pricing rule in the long run. |
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Keywords: | |
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