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Pricing Discretion and Price Regulation in Competitive Industries

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Author Info

  • Alberto Iozzi

    ()
    (Universita degli Studi di Roma)

  • Roberta Sestini

    ()
    (University of Rome I)

  • Edilio Valentini

    ()
    (Universita D'Annunzio)

Abstract

Price capped firms enjoy a large degree of pricing discretion, which may damage captive customers and have adverse effects on the development of competition when regulated firms also operate in competitive industries. We study two alternative regulatory approaches to limit such a discretion. The first one places a fixed upper limit to the prices charged in captive markets; the other constrains the captive prices relatively to the price asset in the more competitive markets. We refer to the former approach as the Absolute regime, and to the latter as the Relative regime. We analyse the effects on prices, competition, and welfare stemming from the two regimes in a simple model where the regulated firm faces competition by a competitive fringe in some of the markets it serves. We find that the Relative regime is not much more effective in protecting captive customers since captive prices may be identical under both regimes. Moreover, since it makes more costly to the incumbent regulated firm to reduce its competitive price, this is weakly higher than under the Absolute regime. However, this is also the reason why the Relative regime turns out to be more pro-competitive: the total output supplied by competitors and/or the number of firms entering the potentially competitive market might be enhanced under this rule. The effects on aggregate welfare are ambiguous. We provide some evidence that the Relative regime is more likely to positively affect consumers' surplus and social welfare the more efficient is the competitive fringe.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 69.

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Length: 26
Date of creation: 04 Apr 2005
Date of revision:
Handle: RePEc:rtv:ceisrp:69

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Keywords: price regulation; pricing discretion; competition;

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References

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  1. Anton, James J. & Vander Weide, James H. & Vettas, Nikolaos, 2002. "Entry auctions and strategic behavior under cross-market price constraints," International Journal of Industrial Organization, Elsevier, vol. 20(5), pages 611-629, May.
  2. repec:ccp:journl:v:53:y:2000:i:3:p:161-175 is not listed on IDEAS
  3. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, December.
  4. Alberto Iozzi, 2001. "Strategic pricing and entry deterrence under price-cap regulation," Journal of Economics, Springer, vol. 74(3), pages 283-300, October.
  5. Armstrong, Mark & Vickers, John, 2000. "Multiproduct Price Regulation under Asymmetric Information," Journal of Industrial Economics, Wiley Blackwell, vol. 48(2), pages 137-60, June.
  6. John Vickers, 2005. "Abuse of Market Power," Economic Journal, Royal Economic Society, vol. 115(504), pages F244-F261, 06.
  7. Otero, Jesus & Waddams Price, Catherine, 2001. "Price Discrimination, Regulation and Entry in the UK Residential Electricity Market," Bulletin of Economic Research, Wiley Blackwell, vol. 53(3), pages 161-75, July.
  8. Mark Armstrong & John Vickers, 1991. "Welfare Effects of Price Discrimination by a Regulated Monopolist," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 571-581, Winter.
  9. Alberto Iozzi & Marco Fioramanti, 2004. "Strategic Choice of the Price Structure and Entry Deterrence Under Price Cap Regulation," Bulletin of Economic Research, Wiley Blackwell, vol. 56(4), pages 333-352, October.
  10. Armstrong, Mark & Doyle, Chris & Vickers, John, 1996. "The Access Pricing Problem: A Synthesis," Journal of Industrial Economics, Wiley Blackwell, vol. 44(2), pages 131-50, June.
  11. Varian, Hal R., 1989. "Price discrimination," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 10, pages 597-654 Elsevier.
  12. Ireland, Norman J, 1992. "On the Welfare Effects of Regulating Price Discrimination," Journal of Industrial Economics, Wiley Blackwell, vol. 40(3), pages 237-48, September.
  13. Dieter Bös & Lorenz Nett, 1990. "Privatization, price regulation, and market entry an asymmetric multistage Duopoly model," Journal of Economics, Springer, vol. 51(3), pages 221-257, October.
  14. Armstrong, M. & Vickers, J., 1992. "Price Discrimination, Competition and Regulation," Economics Series Working Papers 99140, University of Oxford, Department of Economics.
  15. Armstrong, Mark & Sappington, David E.M., 2007. "Recent Developments in the Theory of Regulation," Handbook of Industrial Organization, Elsevier.
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Cited by:
  1. Kevin Currier, 2009. "Price cap regulation of a dominant firm facing competition," Journal of Economics, Springer, vol. 98(3), pages 221-233, December.

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