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Setting the X Factor in Price Cap Regulation Plans

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  • Jeffrey I. Bernstein
  • David E. M. Sappington

Abstract

Despite the popularity of price cap regulation in practice, the economic literature provides relatively little guidance on how to determine the X factor, which is the rate at which inflation -adjusted output prices must fall under price cap plans. We review the standard principles that inform the choice of the X factor, and then consider important extensions. We analyze appropriate modifications of the X factor: (1) when only a subset of the firm's products are subject to price cap regulation, and when product-specific costs and productivity cannot be measured; (2) when the pricing decisions of the regulated firm affect the economy-wide inflation rate; and (3) in the presence of structural changes in the industry, such as a strengthening of competitive forces.

Suggested Citation

  • Jeffrey I. Bernstein & David E. M. Sappington, 1998. "Setting the X Factor in Price Cap Regulation Plans," NBER Working Papers 6622, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6622
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    1. Dag Morten Dalen, 1998. "Yardstick Competition and Investment Incentives," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 7(1), pages 105-126, March.
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    13. David Sappington, 1996. "Designing Incentive Regulation for the Telecommunications Industry," Books, American Enterprise Institute, number 52863.
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    More about this item

    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity

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