The "demand side" effect of price caps: uncertainty, imperfect competition, and rationing
AbstractPrice caps are often used by policy makers to "regulate markets". Previous analyses have focussed on the "supply side" impact of these caps, and derived the optimal price cap, which maximizes investment and welfare. This article expands the analysis to include the "demand side" impact of price caps: when prices can no longer rise, customers must be rationed to adjust demand to available supply. This yields two new findings, that contradict previous analyses. First, the welfare-maximizing cap is higher than the capacity-maximizing cap, since increasing the cap increases gross surplus when customers are rationed. Second, in somes cases, the capacity-maximizing cap leads to lower capacity and welfare than no cap. These findings underscores the importance for policy makers to examine the impact on customers when they impose price caps.
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Bibliographic InfoPaper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 815.
Date of creation: 27 Jan 2014
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price caps; imperfect competition; rationing; investment incentives;
Find related papers by JEL classification:
- L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
- L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-02-08 (All new papers)
- NEP-IND-2014-02-08 (Industrial Organization)
- NEP-MKT-2014-02-08 (Marketing)
- NEP-REG-2014-02-08 (Regulation)
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