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Network Investment and the Threat of Regulation – Preventing Monopoly Exploitation or Infrastructure Construction?

  • Ulrich Blum
  • Christian Growitsch
  • Niels Krap

In summer 2005, the German telecommunication incumbent Deutsche Telekom announced its plans to build a new broadband fibre optics network. Deutsche Telekom decided as precondition for this new network not to be regulated with respect to pricing and third party access. To develop a regulator's strategy that allows investments and prevents monopolistic prices at the same time, we model an incumbent's decision problem under a threat of regulation in a game-theoretical context. The decision whether to invest or not depends on the probability of regulation and its assumed impact on investment returns. Depending on the incumbent's expectation on these parameters, he will decide if the investment is favourable, and which price to best set. This price is below a non-regulated profit maximising price, since the incumbent tries to circumvent regulation. Thus, we show that the mere threat of a regulator's intervention might prevent supernormal profits without actual price regulation. The regulator, on the other hand, can influence both investment decision and the incumbent's price via his signals on regulation probability and price. These signals an be considered optimal, if they simultaneously allow investment and minimize the incumbent's price.

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Paper provided by Halle Institute for Economic Research in its series IWH Discussion Papers with number 7.

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Date of creation: May 2006
Date of revision:
Handle: RePEc:iwh:dispap:7-06
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  1. Evans, Lewis & Guthrie, Graeme, 2005. "Risk, Price Regulation, and Irreversible Investment," Working Paper Series 3880, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
  2. repec:lan:wpaper:1193 is not listed on IDEAS
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  4. Elizabeth Olmstead Teisberg, 1993. "Capital Investment Strategies under Uncertain Regulation," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 591-604, Winter.
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  6. Ian M. Dobbs, 2004. "Intertemporal price cap regulation under uncertainty," Economic Journal, Royal Economic Society, vol. 114(495), pages 421-440, 04.
  7. Gert Brunekreeft, 2004. "Regulatory Threat in Vertically Related Markets: The Case of German Electricity," European Journal of Law and Economics, Springer, vol. 17(3), pages 285-305, May.
  8. C F Elliott & M Z Acutt, 2001. "Threat-based regulation and endogenously determined punishments," Working Papers 539877, Lancaster University Management School, Economics Department.
  9. repec:lan:wpaper:1128 is not listed on IDEAS
  10. David Starkie, 2001. "A new deal of airports," Chapters, in: Regulating Utilities, chapter 7 Edward Elgar.
  11. Jean-Daniel Saphores & Eric Gravel & Jean-Thomas Bernard, 2004. "Regulation and Investment under Uncertainty: An Application to Power Grid Interconnection," Journal of Regulatory Economics, Springer, vol. 25(2), pages 169-186, 03.
  12. Littlechild Stephen, 2003. "Reflections on Incentive Regulation," Review of Network Economics, De Gruyter, vol. 2(4), pages 1-27, December.
  13. Mandy David M. & Sharkey William W., 2003. "Dynamic Pricing and Investment from Static Proxy Models," Review of Network Economics, De Gruyter, vol. 2(4), pages 1-37, December.
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