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Price Regulation under Demand Uncertainty

Author

Listed:
  • Grimm Veronika

    () (University of Erlangen-Nuremberg)

  • Zöttl Gregor

    () (University of Munich (LMU))

Abstract

In this paper we provide a taxonomy of price cap regulation in oligopoly under demand uncertainty. We show that independently of the nature of uncertainty high price caps always increase production and welfare as compared to setting no price cap. We also derive conditions on the demand distribution under which a price cap close to marginal cost can be optimal and when it is not. For demand distributions with an increasing hazard rate we show that price regulation under demand uncertainty can be viewed as a well behaved extension of the analysis for deterministic demand. For this class of distributions we characterize the optimal price cap, which is unique and may or may not be close to marginal cost. Our general framework nests the limit case of deterministic demand as well as results by Earle et al. (2007), who have shown that standard arguments supporting the imposition of price caps may break down in the presence of demand uncertainty.

Suggested Citation

  • Grimm Veronika & Zöttl Gregor, 2010. "Price Regulation under Demand Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-34, June.
  • Handle: RePEc:bpj:bejtec:v:10:y:2010:i:1:n:26
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    References listed on IDEAS

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    1. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-557, June.
    2. Robert Earle & Karl Schmedders & Tymon Tatur, 2007. "On Price Caps Under Uncertainty," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 93-111.
    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. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, January.
    5. Rabah Amir & Val E. Lambson, 2000. "On the Effects of Entry in Cournot Markets," Review of Economic Studies, Oxford University Press, vol. 67(2), pages 235-254.
    6. Ian M. Dobbs, 2004. "Intertemporal price cap regulation under uncertainty," Economic Journal, Royal Economic Society, vol. 114(495), pages 421-440, April.
    7. Gary Biglaiser & Michael Riordan, 2000. "Dynamics of Price Regulation," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 744-767, Winter.
    8. Lagerlöf Johan N.M., 2006. "Equilibrium Uniqueness in a Cournot Model with Demand Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 6(1), pages 1-6, December.
    9. Quirmbach, Herman C, 1988. "Comparative Statics for Oligopoly: Demand Shift Effects," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(3), pages 451-459, August.
    10. Ellen M. Pint, 1992. "Price-Cap versus Rate-of-Return Regulation in a Stochastic-Cost Model," RAND Journal of Economics, The RAND Corporation, vol. 23(4), pages 564-578, Winter.
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    Citations

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    Cited by:

    1. Stanley Reynolds & David Rietzke, 2015. "Price caps, oligopoly, and entry," Working Papers 80998880, Lancaster University Management School, Economics Department.
    2. repec:kap:jeczfn:v:121:y:2017:i:2:d:10.1007_s00712-017-0521-0 is not listed on IDEAS
    3. Lemus Torres, Ana Belén & Moreno Ruiz, Diego, 2014. "Price caps regulation with capacity precommitment," UC3M Working papers. Economics we1309, Universidad Carlos III de Madrid. Departamento de Economía.
    4. Lemus, Ana B. & Moreno, Diego, 2017. "Price caps with capacity precommitment," International Journal of Industrial Organization, Elsevier, vol. 50(C), pages 131-158.
    5. Zöttl, Gregor, 2011. "On optimal scarcity prices," International Journal of Industrial Organization, Elsevier, vol. 29(5), pages 589-605, September.

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