Price cap regulation with capacity withholding
AbstractA monopolist facing an uncertain demand makes ex-ante capacity decisions involving irreversible investments, and then chooses its output up to capacity upon the realization of demand. In equilibrium, capacity is low and underused. Imposing a binding price cap leads to an increase of capacity as well as expected output and total surplus, and to a decrease of expected price. The optimal price cap trades off the incentives for capacity investment and capacity withholding, and is well above the marginal cost. Price cap regulation alone cannot eliminate inefficiencies. When the unit cost of capacity is high the comparative static properties of price caps relative to the price cap than maximizes capacity investment ?* are analogous to those obtained when the demand is known with certainty, and the optimal price cap is ?*. When the unit cost of capacity is low, however, the expected output and surplus decrease with the price cap above and around ?*, and therefore the optimal price cap is below ?*.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we1309.
Date of creation: May 2013
Date of revision:
Monopoly; Market power; Price cap regulation; Capacity investment; Capacity withholding; Demand uncertainty;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-05-24 (All new papers)
- NEP-ENE-2013-05-24 (Energy Economics)
- NEP-REG-2013-05-24 (Regulation)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- Jean J. Gabszewicz & Sougata Poddar, 1997.
"Demand fluctuations and capacity utilization under duopoly,"
Springer, vol. 10(1), pages 131-146.
- GABSZEWICZ, Jean J. & PODDAR , Sougata, 1995. "Demand Fluctuations and Capacity Utilization under Duopoly," CORE Discussion Papers 1995051, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Gabszewicz, J.J. & Poddar, S., . "Demand fluctuations and capacity utilization under duopoly," CORE Discussion Papers RP -1269, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June.
- Grimm Veronika & Zöttl Gregor, 2010. "Price Regulation under Demand Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-34, June.
- Reynolds, Stanley S. & Wilson, Bart J., 2000. "Bertrand-Edgeworth Competition, Demand Uncertainty, and Asymmetric Outcomes," Journal of Economic Theory, Elsevier, vol. 92(1), pages 122-141, May.
- Ian M. Dobbs, 2004. "Intertemporal price cap regulation under uncertainty," Economic Journal, Royal Economic Society, vol. 114(495), pages 421-440, 04.
- Cabral, Luis M B & Riordan, Michael H, 1989. "Incentives for Cost Reduction under Price Cap Regulation," Journal of Regulatory Economics, Springer, vol. 1(2), pages 93-102, June.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.