Price caps regulation with capacity precommitment
Contrary to a recent literature that questions whether price caps are effective, and even sensitive, under demand uncertainty, we show that in the absence of quantity precommitment the effects of a price cap are the same whether the demand is uncertain or deterministic. Next we study the effectiveness of a price cap to regulate a monopoly that makes irreversible capacity investments ex-ante, and then chooses its output up to capacity upon observing the realization of demand. In this more interesting scenario the optimal price cap, which must trade off the incentives for capacity investment and capacity withholding, is well above the unit cost of capacity, and may be below the price cap that maximizes capacity. Further, under standard assumptions on the demand distribution the comparative static properties of price caps above the optimal price cap are analogous to those they have in the absence of capacity precommitment. Nevertheless, a price cap alone cannot eliminate inefficiencies.
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|Date of revision:||Aug 2014|
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