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Price caps with capacity precommitment

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  • Lemus, Ana B.
  • Moreno, Diego

Abstract

We examine the effectiveness of price caps to regulate imperfectly competitive markets in which the demand is uncertain. To that effect, we study a monopoly that makes irreversible capacity investments ex-ante, and then chooses its output up to capacity upon observing the realization of demand. We show that the optimal price cap must trade off the incentives for capacity investment and capacity withholding, and is above the unit cost of capacity. Moreover, while a price cap provides incentives for capacity investment and mitigates market power, it cannot eliminate inefficiencies. Capacity payments provide a useful complementary instrument.

Suggested Citation

  • Lemus, Ana B. & Moreno, Diego, 2017. "Price caps with capacity precommitment," International Journal of Industrial Organization, Elsevier, vol. 50(C), pages 131-158.
    • Handle: RePEc:eee:indorg:v:50:y:2017:i:c:p:131-158
    DOI: 10.1016/j.ijindorg.2016.11.005
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    References listed on IDEAS

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    4. Somogyi, Robert, 2020. "Bertrand–Edgeworth competition with substantial horizontal product differentiation," Mathematical Social Sciences, Elsevier, vol. 108(C), pages 27-37.

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