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Optimal price-cap reviews

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  • Coco, Giuseppe
  • De Vincenti, Claudio

Abstract

This paper demonstrates, in a dynamic model of monopoly regulation with price-cap, that a periodic price review may increase productive efficiency. When the firm's choice of cost-reducing effort depends on the volume of output supplied, a periodic revision allows the regulator to set more binding prices, thus inducing the monopolist to exert more cost-reducing effort in the future. In a continuous-time setting we establish the conditions under which, within a given concession period, a single full rate base review improves cost-efficiency, and by this route, we also establish the optimal number of reviews. This number depends on the length of the concession period in relation to the slope of the demand function and the intensity of the disutility of effort. Our results add both a theoretical argument in favour of the practice of periodic reviews in price-cap regulation and provide regulators with a basis for the calculation of the optimal regulatory lag. Potentially, our argument is relevant to every regulated monopolist, including the utilities' networks. A particular case worth mentioning is the regulation of toll-road tariffs, particularly in the case of a newly privatized toll-road concessionaire.

Suggested Citation

  • Coco, Giuseppe & De Vincenti, Claudio, 2008. "Optimal price-cap reviews," Utilities Policy, Elsevier, vol. 16(4), pages 238-244, December.
  • Handle: RePEc:eee:juipol:v:16:y:2008:i:4:p:238-244
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    References listed on IDEAS

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    1. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, January.
    2. 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.
    3. Michele Moretto & Chiara D.Alpaos & Cesare Dosi, 2005. "Concession Length and Investment Timing Flexibility," Working Papers 2005.32, Fondazione Eni Enrico Mattei.
    4. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, pages 755-785.
    5. J. Luis Guasch & St├ęphane Straub, 2006. "Renegotiation Of Infrastructure Concessions: An Overview," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 77(4), pages 479-493, December.
    6. Kenneth Arrow, 1962. "Economic Welfare and the Allocation of Resources for Invention," NBER Chapters,in: The Rate and Direction of Inventive Activity: Economic and Social Factors, pages 609-626 National Bureau of Economic Research, Inc.
    7. Tracy R. Lewis & Huseyin Yildirim, 2002. "Learning by Doing and Dynamic Regulation," RAND Journal of Economics, The RAND Corporation, pages 22-36.
    8. Laffont, Jean-Jacques & Tirole, Jean, 1986. "Using Cost Observation to Regulate Firms," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 614-641, June.
    9. Coco, Giuseppe & De Vincenti, Claudio, 2004. "Can price regulation increase cost-efficiency?," Research in Economics, Elsevier, pages 303-317.
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    Cited by:

    1. Marco Ponti, 2011. "Competition, Regulation and Public Service Obligations," Chapters,in: A Handbook of Transport Economics, chapter 28 Edward Elgar Publishing.

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    Keywords

    Price-cap Rate base review;

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