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 ?*.
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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)
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