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Price-Cap versus Rate-of-Return Regulation in a Stochastic-Cost Model

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  • Ellen M. Pint
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    Abstract

    A stochastic-cost model is used to show that both price-cap and rate-of-return regulation lead to overinvestment in capital and to excessive managerial slack. However, they differ in stochastic versus fixed intervals between hearings and in the use of test-year costs versus average costs since the previous hearing. A numerical example illustrates that fixed intervals between hearings improve welfare if hearings are not held too frequently, but most gains go to the firm. More significantly, the use of average-cost data combined with fixed intervals results in dramatic welfare improvements, with most gains going to consumers.

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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): 4 (Winter)
    Pages: 564-578

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    Handle: RePEc:rje:randje:v:23:y:1992:i:winter:p:564-578

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    Cited by:
    1. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
    2. Bernstein, Jeffrey I & Sappington, David E M, 1999. "Setting the X Factor in Price-Cap Regulation Plans," Journal of Regulatory Economics, Springer, vol. 16(1), pages 5-25, July.
    3. Harstad, Bård & Eskeland, Gunnar S., 2010. "Trading for the Future: Signaling in Permit Markets," Discussion Papers 2010/2, Department of Business and Management Science, Norwegian School of Economics.
    4. Kopsakangas-Savolainen, Maria & Svento, Rauli, 2010. "Comparing welfare effects of different regulation schemes: An application to the electricity distribution industry," Energy Policy, Elsevier, vol. 38(11), pages 7370-7377, November.
    5. Glazer, Amihai, 2001. "Regulatory tune-ups," Information Economics and Policy, Elsevier, vol. 13(4), pages 427-438, December.
    6. Ai, Chunrong & Sappington, David E.M., 2005. "Reviewing the impact of incentive regulation on U.S. telephone service quality," Utilities Policy, Elsevier, vol. 13(3), pages 201-210, September.
    7. Ariel Casarin, 2014. "Productivity throughout regulatory cycles in gas utilities," Journal of Regulatory Economics, Springer, vol. 45(2), pages 115-137, April.
    8. Roques, F.A. & Savva , N.S., 2006. "Price Cap Regulation and Investment Incentives under Demand Uncertainty," Cambridge Working Papers in Economics 0636, Faculty of Economics, University of Cambridge.
    9. Burns, Phil & Riechmann, Christoph, 2004. "Regulatory instruments and investment behaviour," Utilities Policy, Elsevier, vol. 12(4), pages 211-219, December.
    10. Roques, Fabien A. & Savva, Nicos, 2009. "Investment under uncertainty with price ceilings in oligopolies," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 507-524, February.

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