Dynamic revised price-cap regulation: Eliminating inefficiency, preventing Ramsey convergence, and aligning firm–consumer welfare

Price-cap regulation has long served as the cornerstone of public-utility regulation. First, when a monopoly operates under economies of scale, marginal-cost pricing generates losses, so regulators often adopt Ramsey pricing as the second-best solution. Our study challenges the canonical convergence claim by showing that the traditional price-cap adjustment processes proposed by Vogelsang and Finsinger (1979) and Vogelsang (1989) do not necessarily imply convergence to Ramsey pricing. Second, Sappington (1980) and Hagerman (1990) argue that conventional price-cap schemes fail to sustain production efficiency. To address both shortcomings, we develop the Revised Price-Cap Regulation, which integrates a price-cap adjustment rule for economies-of-scale monopolies. Our theoretical model applies broadly to regulated utilities—including electricity, water, rail, natural gas, aviation, pharmaceuticals, and network industries—where price-cap regimes remain prevalent. The model delivers three advantages. First, firms maintain production efficiency and avoid the inefficiency trap. Second, although Ramsey conditions create incentives to raise prices, the efficiency requirement prevents steady-state convergence to Ramsey pricing. Third, the mechanism aligns consumer and firm interests because higher firm profits translate into higher consumer welfare through benefit sharing. These results provide a rigorous foundation for designing incentive regulation and refining the regulatory doctrine.