The Incremental Surplus Subsidy and Rate-of-Return Regulation
D. Sappington and D. Sibley (1988) propose an alternative regulatory mechanism, the Incremental Surplus Subsidy (ISS), that would induce the regulated firm to set price at marginal cost and eliminate all waste. The ISS would give the firm a subsidy equal to the one-period gain in consumer surplus resulting from its pricing decision. This article shows that the ISS does not induce greater production efficiency than traditional rate-of-return (ROR) regulation. The author proposes a "super-ISS" mechanism that would give the firm a subsidy greater than the gain in consumer surplus resulting from its pricing decisions. This super-ISS mechanism is shown to result in greater benefits than either ISS or ROR regulation. Copyright 1992 by Kluwer Academic Publishers
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