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Network Investment and the Threat of Regulation – Preventing Monopoly Exploitation or Infrastructure Construction?

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Author Info

  • Ulrich Blum
  • Christian Growitsch
  • Niels Krap

Abstract

In summer 2005, the German telecommunication incumbent Deutsche Telekom announced its plans to build a new broadband fibre optics network. Deutsche Telekom decided as precondition for this new network not to be regulated with respect to pricing and third party access. To develop a regulator's strategy that allows investments and prevents monopolistic prices at the same time, we model an incumbent's decision problem under a threat of regulation in a game-theoretical context. The decision whether to invest or not depends on the probability of regulation and its assumed impact on investment returns. Depending on the incumbent's expectation on these parameters, he will decide if the investment is favourable, and which price to best set. This price is below a non-regulated profit maximising price, since the incumbent tries to circumvent regulation. Thus, we show that the mere threat of a regulator's intervention might prevent supernormal profits without actual price regulation. The regulator, on the other hand, can influence both investment decision and the incumbent's price via his signals on regulation probability and price. These signals an be considered optimal, if they simultaneously allow investment and minimize the incumbent's price.

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Bibliographic Info

Paper provided by Halle Institute for Economic Research in its series IWH Discussion Papers with number 7.

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Date of creation: May 2006
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Handle: RePEc:iwh:dispap:7-06

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Related research

Keywords: regulation; investment; telecommunication; network industries;

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References

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  1. C F Elliott & M Z Acutt, 2001. "Threat-based regulation and endogenously determined punishments," Working Papers 539877, Lancaster University Management School, Economics Department.
  2. Glazer, Amihai & McMillan, Henry, 1992. "Pricing by the Firm under Regulatory Threat," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 1089-99, August.
  3. repec:lan:wpaper:1128 is not listed on IDEAS
  4. Gert Brunekreeft, 2004. "Regulatory Threat in Vertically Related Markets: The Case of German Electricity," European Journal of Law and Economics, Springer, vol. 17(3), pages 285-305, May.
  5. Littlechild Stephen, 2003. "Reflections on Incentive Regulation," Review of Network Economics, De Gruyter, vol. 2(4), pages 1-27, December.
  6. repec:lan:wpaper:1193 is not listed on IDEAS
  7. Ian M. Dobbs, 2004. "Intertemporal price cap regulation under uncertainty," Economic Journal, Royal Economic Society, vol. 114(495), pages 421-440, 04.
  8. repec:lan:wpaper:1107 is not listed on IDEAS
  9. Evans, Lewis T. & Guthrie, Graeme A., 2005. "Risk, price regulation, and irreversible investment," International Journal of Industrial Organization, Elsevier, vol. 23(1-2), pages 109-128, February.
  10. Elizabeth Olmstead Teisberg, 1993. "Capital Investment Strategies under Uncertain Regulation," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 591-604, Winter.
  11. Mandy David M. & Sharkey William W., 2003. "Dynamic Pricing and Investment from Static Proxy Models," Review of Network Economics, De Gruyter, vol. 2(4), pages 1-37, December.
  12. Jean-Daniel Saphores & Eric Gravel & Jean-Thomas Bernard, 2004. "Regulation and Investment under Uncertainty: An Application to Power Grid Interconnection," Journal of Regulatory Economics, Springer, vol. 25(2), pages 169-186, 03.
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Cited by:
  1. Chisari, Omar O. & Kessides, Ioannis N., 2007. "The pricing dynamics of utilities with underdeveloped networks," Policy Research Working Paper Series 4198, The World Bank.

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