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Setting the X Factor in Price Cap Regulation Plans

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

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6622.

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Date of creation: Jun 1998
Date of revision:
Publication status: published as Journal of Regulatory Economics, Vol. 16 (1999): 5-25.
Handle: RePEc:nbr:nberwo:6622
Note: PR
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  1. John E. Kwoka, 1993. "Implementing price cops in telecommunications," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 12(4), pages 726-752.
  2. Tracy R. Lewis & David E.M. Sappington, 1989. "Regulatory Options and Price-Cap Regulation," RAND Journal of Economics, The RAND Corporation, vol. 20(3), pages 405-416, Autumn.
  3. Dag Morten Dalen, 1998. "Yardstick Competition and Investment Incentives," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 7(1), pages 105-126, 03.
  4. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, June.
  5. Brennan, Timothy J, 1989. "Regulating by Capping Prices," Journal of Regulatory Economics, Springer, vol. 1(2), pages 133-47, June.
  6. M.E. Beesley & S.C. Littlechild, 1989. "The Regulation of Privatized Monopolies in the United Kingdom," RAND Journal of Economics, The RAND Corporation, vol. 20(3), pages 454-472, Autumn.
  7. Ellen M. Pint, 1992. "Price-Cap versus Rate-of-Return Regulation in a Stochastic-Cost Model," RAND Journal of Economics, The RAND Corporation, vol. 23(4), pages 564-578, Winter.
  8. Richard Schmalensee, 1989. "Good Regulatory Regimes," RAND Journal of Economics, The RAND Corporation, vol. 20(3), pages 417-436, Autumn.
  9. Andrei Shleifer, 1985. "A Theory of Yardstick Competition," RAND Journal of Economics, The RAND Corporation, vol. 16(3), pages 319-327, Autumn.
  10. Staranczak, Genio A. & Sepulveda, Edgardo R. & Dilworth, Peter A. & Shaikh, Shafi A., 1994. "Industry structure, productivity and international competitiveness: the case of telecommunications," Information Economics and Policy, Elsevier, vol. 6(2), pages 121-142, July.
  11. David Sappington, 1996. "Designing Incentive Regulation for the Telecommunications Industry," Books, American Enterprise Institute, number 52863, September.
  12. Nadiri, M. Ishaq & Nandi, Banani, 1997. "The changing structure of cost and demand for the U.S. telecommunications industry," Information Economics and Policy, Elsevier, vol. 9(4), pages 319-347, December.
  13. Cabral, Luis M B & Riordan, Michael H, 1989. "Incentives for Cost Reduction under Price Cap Regulation," Journal of Regulatory Economics, Springer, vol. 1(2), pages 93-102, June.
  14. Diewert, W.E., 1993. "Duality approaches to microeconomic theory," Handbook of Mathematical Economics, in: K. J. Arrow & M.D. Intriligator (ed.), Handbook of Mathematical Economics, edition 4, volume 2, chapter 12, pages 535-599 Elsevier.
  15. Bernstein, Jeffrey I., 1987. "An Examination of the Equilibrium Specification and Structure of Production for Canadian Telecommunications," Working Papers 87-21, C.V. Starr Center for Applied Economics, New York University.
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