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Optimal Pricing and Entry Rules When a Regulated Dominant Firm Faces a Competitive Fringe

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  • Kevin Currier

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Abstract

In this paper, we study optimal regulation of a dominant firm facing an unregulated competitive fringe. First, assuming the size of the fringe is fixed, we demonstrate that the usual Ramsey Rule for second-best efficient pricing remains applicable in this context. We also examine the suitability of the Laspeyres price cap and show that it retains its desirable properties. This implies that regulators should continue to apply Laspeyres price cap regulation to the dominant firm after competition has materialized. Then, assuming that price and entry control are regulatory instruments, we characterize the efficient pricing and entry rules. We demonstrate that the free entry equilibrium number of firms will be excessive relative to the efficient number of firms, thereby providing a new Excess Entry Theorem. Finally, we suggest a modification of the Laspeyres price cap that can incentivize the regulated dominant firm to support efficient entry into the fringe. Copyright International Atlantic Economic Society 2011

Suggested Citation

  • Kevin Currier, 2011. "Optimal Pricing and Entry Rules When a Regulated Dominant Firm Faces a Competitive Fringe," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 17(4), pages 465-475, November.
  • Handle: RePEc:kap:iaecre:v:17:y:2011:i:4:p:465-475:10.1007/s11294-011-9317-0
    DOI: 10.1007/s11294-011-9317-0
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    References listed on IDEAS

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    1. Armstrong, Mark & Vickers, John, 1993. "Price Discrimination, Competition and Regulation," Journal of Industrial Economics, Wiley Blackwell, vol. 41(4), pages 335-359, December.
    2. Bernstein, Jeffrey I & Sappington, David E M, 1999. "Setting the X Factor in Price-Cap Regulation Plans," Journal of Regulatory Economics, Springer, vol. 16(1), pages 5-25, July.
    3. Paula Sarmento & António Brandão, 2007. "Entry Deterrence and Entry Accommodation Strategies of a Multiproduct Firm Regulated with Dynamic Price Cap," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 13(1), pages 19-34, February.
    4. Kevin M. Currier, 2007. "Quality-Corrected Price Caps," Bulletin of Economic Research, Wiley Blackwell, vol. 59(3), pages 255-268, July.
    5. Cabral, Luis M B & Riordan, Michael H, 1989. "Incentives for Cost Reduction under Price Cap Regulation," Journal of Regulatory Economics, Springer, vol. 1(2), pages 93-102, June.
    6. Brennan, Timothy J, 1989. "Regulating by Capping Prices," Journal of Regulatory Economics, Springer, vol. 1(2), pages 133-147, June.
    7. Laffont, Jean-Jacques & Tirole, Jean, 1996. "Creating Competition through Interconnection: Theory and Practice," Journal of Regulatory Economics, Springer, vol. 10(3), pages 227-256, November.
    8. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
    9. Ingo Vogelsang & Jorg Finsinger, 1979. "A Regulatory Adjustment Process for Optimal Pricing by Multiproduct Monopoly Firms," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 157-171, Spring.
    10. Currier, Kevin M., 0. "A practical approach to quality-adjusted price cap regulation," Telecommunications Policy, Elsevier, vol. 31(8-9), pages 493-501, September.
    11. Vogelsang, Ingo, 2002. "Incentive Regulation and Competition in Public Utility Markets: A 20-Year Perspective," Journal of Regulatory Economics, Springer, vol. 22(1), pages 5-27, July.
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    More about this item

    Keywords

    Price cap regulation; Liberalization; Excess entry; L43; L51;

    JEL classification:

    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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