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The "demand side" effect of price caps: uncertainty, imperfect competition, and rationing

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  • Léautier, Thomas-Olivier
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    Abstract

    Price 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 Info

    Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 815.

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    Date of creation: 27 Jan 2014
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    Handle: RePEc:ide:wpaper:27858

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    Keywords: price caps; imperfect competition; rationing; investment incentives;

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    1. Paul Joskow & Jean Tirole, 2004. "Reliability and Competitive Electricity Markets," Working Papers 0408, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
    2. Lewis Evans & Graeme Guthrie, 2012. "Price-cap regulation and the scale and timing of investment," RAND Journal of Economics, RAND Corporation, vol. 43(3), pages 537-561, 09.
    3. Mougeot, Michel & Naegelen, Florence, 2005. "Hospital price regulation and expenditure cap policy," Journal of Health Economics, Elsevier, vol. 24(1), pages 55-72, January.
    4. Michael A. Crew & Paul R. Kleindorfer, 1976. "Peak Load Pricing with a Diverse Technology," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 207-231, Spring.
    5. 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.
    6. Lijesen, Mark G., 2007. "The real-time price elasticity of electricity," Energy Economics, Elsevier, vol. 29(2), pages 249-258, March.
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