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Trigger Price Regulation

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  • David J. Salant
  • Glenn A. Woroch

Abstract

We consider the difficulty of achieving efficient prices and investments when returns on a public utility's projects are vulnerable to opportunistic ratemaking. We model the long-term relationship between a firm and its regulator as a time-dependent supergame in which the regulator sets price ceilings to maximize surplus and the firm invests to maximize profit. We find history-dependent strategies that support self-enforcing, mutually beneficial equilibria. Equilibrium payoffs are close to the planning solution provided interest rates are small enough and capital depreciates fast enough. We concentrate on "trigger price regulation" where, in response to inefficient behavior, the regulator cuts price down to operating cost and the firm curtails investment. This mechanism performs well even with production economies and with restrictions on players' threats.

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Bibliographic Info

Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 23 (1992)
Issue (Month): 1 (Spring)
Pages: 29-51

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Handle: RePEc:rje:randje:v:23:y:1992:i:spring:p:29-51

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Cited by:
  1. Wirl, Franz, 2010. "Dynamic demand and noncompetitive intertemporal output adjustments," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 28(3), pages 220-229, May.
  2. Carlos Pérez Montes, 2011. "Optimal capital structure and Regulatory Control," Banco de Espa�a Working Papers, Banco de Espa�a 1128, Banco de Espa�a.
  3. Roland Strausz, 2009. "Regulatory Risk under Optimal Incentive Regulation," SFB 649 Discussion Papers, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany SFB649DP2009-006, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  4. Mark Armstrong & David Sappington, 2005. "Regulation, Competition and Liberalization," Industrial Organization, EconWPA 0505011, EconWPA, revised 07 Oct 2005.
  5. Wren-Lewis, Liam, 2013. "Commitment in utility regulation: A model of reputation and policy applications," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 89(C), pages 210-231.
  6. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 44(4), pages 925-972, December.

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