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Dynamics of Price Regulation

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  • Gary Biglaiser
  • Michael Riordan

Abstract

We study the dynamics of price regulation for an industry adjusting to exogenous technological progress. First, we characterize the optimal capacity path and replacement cycles in a neoclassical investment model. Second, we show that naive rate-of-return regulation, which ignores components of economic depreciation, eventually results in a deficient level of capacity due to excessively high retail prices burdened by the need to recover the underdepreciated costs of historical investments. Third, we explain how price-cap regulation leads to more efficient capital replacement decisions compared to naive rate-of-return regulation, and we show how finite price-cap horizons distort capital replacement decisions compared to optimal regulation. Finally, we interpret recent regulatory reforms in telecommunications markets.

Suggested Citation

  • Gary Biglaiser & Michael Riordan, 2000. "Dynamics of Price Regulation," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 744-767, Winter.
  • Handle: RePEc:rje:randje:v:31:y:2000:i:winter:p:744-767
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Guthrie, Graeme, 2012. "Regulated prices and real options," Telecommunications Policy, Elsevier, vol. 36(8), pages 650-663.
    2. Grimm Veronika & Zöttl Gregor, 2010. "Price Regulation under Demand Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-34, June.
    3. Cullmann, Astrid & Nieswand, Maria, 2016. "Regulation and investment incentives in electricity distribution: An empirical assessment," Energy Economics, Elsevier, vol. 57(C), pages 192-203.
    4. Dominik Schober, 2013. "Refinancing under Yardstick Regulation with Investment Cycles–The Case of Long-Lived Electricity Network Assets," EWL Working Papers 1321, University of Duisburg-Essen, Chair for Management Science and Energy Economics, revised Jun 2013.
    5. Sebastian Nick & Heike Wetzel, 2016. "The hidden cost of investment: the impact of adjustment costs on firm performance measurement and regulation," Journal of Regulatory Economics, Springer, vol. 49(1), pages 33-55, February.
    6. Marija Bartl, 2010. "The Affordability of Energy: How Much Protection for the Vulnerable Consumers?," Journal of Consumer Policy, Springer, vol. 33(3), pages 225-245, September.
    7. Michael Schmidthaler & Jed Cohen & Johannes Reichl & Stefan Schmidinger, 2015. "The effects of network regulation on electricity supply security: a European analysis," Journal of Regulatory Economics, Springer, vol. 48(3), pages 285-316, December.
    8. Ariel Casarin, 2014. "Productivity throughout regulatory cycles in gas utilities," Journal of Regulatory Economics, Springer, vol. 45(2), pages 115-137, April.
    9. Ingo Vogelsang, 2012. "Incentive Regulation, Investments and Technological Change," Chapters,in: Regulation and the Performance of Communication and Information Networks, chapter 4 Edward Elgar Publishing.
    10. Küpper, Hans-Ulrich & Pedell, Burkhard, 2016. "Which asset valuation and depreciation method should be used for regulated utilities? An analytical and simulation-based comparison," Utilities Policy, Elsevier, vol. 40(C), pages 88-103.
    11. Schober, Dominik & Weber, Christoph, 2015. "Refinancing under yardstick regulation with investment cycles: The case of long-lived electricity network assets," ZEW Discussion Papers 15-065, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    12. Alexander Nezlobin & Madhav V. Rajan & Stefan Reichelstein, 2012. "Dynamics of Rate-of-Return Regulation," Management Science, INFORMS, vol. 58(5), pages 980-995, May.
    13. Lewis Evans & Graeme Guthrie, 2006. "Incentive Regulation of Prices When Costs are Sunk," Journal of Regulatory Economics, Springer, vol. 29(3), pages 239-264, May.
    14. Ingo Vogelsang, 2006. "Electricity Transmission Pricing and Performance-based Regulation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 97-126.
    15. Alexander Nezlobin & Madhav V. Rajan & Stefan Reichelstein, 2016. "Structural properties of the price-to-earnings and price-to-book ratios," Review of Accounting Studies, Springer, vol. 21(2), pages 438-472, June.
    16. Guthrie, Graeme, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Working Paper Series 3851, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    17. Cullmann, Astrid & Nieswand, Maria, 2015. "Regulation and Investment Incentives in Electricity Distribution," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113090, Verein für Socialpolitik / German Economic Association.
    18. Rogerson William P, 2011. "On the Relationship Between Historic Cost, Forward Looking Cost and Long Run Marginal Cost," Review of Network Economics, De Gruyter, vol. 10(2), pages 1-31, June.
    19. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
    20. Lemus, Ana B. & Moreno, Diego, 2017. "Price caps with capacity precommitment," International Journal of Industrial Organization, Elsevier, vol. 50(C), pages 131-158.
    21. Nykamp, Stefan & Andor, Mark & Hurink, Johann L., 2012. "‘Standard’ incentive regulation hinders the integration of renewable energy generation," Energy Policy, Elsevier, vol. 47(C), pages 222-237.
    22. Armstrong, Mark & Sappington, David E.M., 2007. "Recent Developments in the Theory of Regulation," Handbook of Industrial Organization, Elsevier.
    23. David E. M Sappington, 2005. "On the Irrelevance of Input Prices for Make-or-Buy Decisions," American Economic Review, American Economic Association, vol. 95(5), pages 1631-1638, December.

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