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Price-Cap versus Rate-of-Return Regulation in a Stochastic-Cost Model

  • Ellen M. Pint
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    A stochastic-cost model is used to show that both price-cap and rate-of-return regulation lead to overinvestment in capital and to excessive managerial slack. However, they differ in stochastic versus fixed intervals between hearings and in the use of test-year costs versus average costs since the previous hearing. A numerical example illustrates that fixed intervals between hearings improve welfare if hearings are not held too frequently, but most gains go to the firm. More significantly, the use of average-cost data combined with fixed intervals results in dramatic welfare improvements, with most gains going to consumers.

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    Article provided by The RAND Corporation in its journal RAND Journal of Economics.

    Volume (Year): 23 (1992)
    Issue (Month): 4 (Winter)
    Pages: 564-578

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    Handle: RePEc:rje:randje:v:23:y:1992:i:winter:p:564-578
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