Regulation and the Option to Delay
AbstractThis paper examines a simple two-period model of an investment decision in a network industry characterized by demand uncertainty, economies of scale and sunk costs. In the absence of regulation we identify the minimum price that an unregulated monopolist demands to bear the demand uncertainty and invest early, that is, the price that incorporates the value of the option to delay. In a regulated environment, we show that in the absence of downstream competition and when the regulator cannot commit to ex-post demand contingent prices, a regulated price that incorporates the option to delay is the minimum price that ensures early investment. Furthermore, when the regulator has a preference for early investment, the option to delay price generates higher welfare than other forms of price regulation. We also show that when the vertically integrated network provider is required to provide access to downstream competitors, and the potential entrant is less efficient than the incumbent, an access price that incorporates the option to delay generates the same investment level output as and higher overall welfare than an unregulated industry that is not required to provide access. By contrast, under the same market conditions an ECPR-based access price generates the same overall welfare than an unregulated industry. Moreover, when the potential entrant is more efficient than the incumbent, an Option to Delay Pricing Rule generates the same investment level output as and (weakly) higher overall welfare than the Efficient Component Pricing Rule (ECPR). In addition, the option-to-delay-based access price is (weakly) lower than the ECPR-based access price.
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Bibliographic InfoPaper provided by School of Economics, University of Queensland, Australia in its series Discussion Papers Series with number 356.
Date of creation: 2008
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-03-08 (All new papers)
- NEP-COM-2008-03-08 (Industrial Competition)
- NEP-MIC-2008-03-08 (Microeconomics)
- NEP-REG-2008-03-08 (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.:
- Robert S. Pindyck, 2005.
"Pricing Capital Under Mandatory Unbundling and Facilities Sharing,"
NBER Working Papers
11225, National Bureau of Economic Research, Inc.
- Pindyck, Robert S., 2005. "Pricing Capital under Mandatory Unbundling and Facilities Sharing," Working paper 337, Regulation2point0.
- Pindyck Robert S., 2007.
"Mandatory Unbundling and Irreversible Investment in Telecom Networks,"
Review of Network Economics,
De Gruyter, vol. 6(3), pages 1-25, September.
- Robert S. Pindyck, 2004. "Mandatory Unbundling and Irreversible Investment in Telecom Networks," NBER Working Papers 10287, National Bureau of Economic Research, Inc.
- repec:reg:rpubli:337 is not listed on IDEAS
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