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The dark side of price cap regulation: a laboratory experiment

Author

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  • Christoph Engel

    (Max Planck Institute for Research on Collective Goods)

  • Klaus Heine

    (Erasmus University Rotterdam, School of Law)

Abstract

In a nutshell, price cap regulation is meant to establish a quid pro quo: regulators are obliged by law to intervene only at rare, previously defined points in time, and only by imposing an upper bound on prices; firms are meant to justify regulatory restraint by adopting socially beneficial innovations. In the policy debate, a potential downside of the arrangement has featured less prominently: the economic environment is unlikely to be stable while the cap is in place. If regulators take this into account, they have to decide under uncertainty and also anticipate how regulated firms will react. In a lab experiment, we manipulate the degree of regulatory uncertainty. We compare a baseline when regulators have the same information as firms about demand with treatments wherein they receive only a noisy signal and another when they know only the distribution from which demand realizations are taken. In the face of uncertainty, regulators impose overly generous price caps, which firms exploit. In the experiment, the social damage is severe, and does not disappear with experience.

Suggested Citation

  • Christoph Engel & Klaus Heine, 2017. "The dark side of price cap regulation: a laboratory experiment," Public Choice, Springer, vol. 173(1), pages 217-240, October.
  • Handle: RePEc:kap:pubcho:v:173:y:2017:i:1:d:10.1007_s11127-017-0473-5
    DOI: 10.1007/s11127-017-0473-5
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    2. Sirin, Selahattin Murat & Erten, Ibrahim, 2022. "Price spikes, temporary price caps, and welfare effects of regulatory interventions on wholesale electricity markets," Energy Policy, Elsevier, vol. 163(C).

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    More about this item

    Keywords

    Price cap regulation; Regulatory uncertainty; Monopoly rent; Experiment;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
    • K21 - Law and Economics - - Regulation and Business Law - - - Antitrust Law
    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation

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