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Dynamics of Yardstick Regulation: Historical Cost Data and the Ratchet E ffect

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  • Meya, Johannes

Abstract

Real life applications of Yardstick Regulation frequently refer to historical cost data. While Yardstick Regulation cuts the link between fi rms own costs and prices firms may charge in a static setting, it does not in a dynamic setting where historical cost data is used. A fi rm can influence the price it will be allowed to charge in the future if its behavior today can e ffect future behavior of other fi rms that determines the price this fi rm will be able to charge later on. This paper shows that, assuming that slack, infl ating of costs, is bene cial to fi rms, a tradeoff between short term profit through abstinence from slack and the benefit of slack in (in finitely) many periods arises. A ratchet eff ect that Yardstick Regulation was meant to overcome can occur and firms can realize positive rents because of the use of historical cost data, even if firms are identical. Equilibria with positive slack can exist without any collusion between fi rms or threat. Moreover, this problem is more severe if the fi rm with lowest costs of all other firms instead of the average fi rm is the yardstick.

Suggested Citation

  • Meya, Johannes, 2013. "Dynamics of Yardstick Regulation: Historical Cost Data and the Ratchet E ffect," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79796, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc13:79796
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    References listed on IDEAS

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    1. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, January.
    2. Andrei Shleifer, 1985. "A Theory of Yardstick Competition," RAND Journal of Economics, The RAND Corporation, vol. 16(3), pages 319-327, Autumn.
    3. Dag Morten Dalen, 1998. "Yardstick Competition and Investment Incentives," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 7(1), pages 105-126, March.
    4. David Sappington, 2005. "Regulating Service Quality: A Survey," Journal of Regulatory Economics, Springer, vol. 27(2), pages 123-154, November.
    5. Martin J. Osborne & Ariel Rubinstein, 1994. "A Course in Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262650401, January.
    6. Georg Meran & Christian Hirschhausen, 2009. "A modified yardstick competition mechanism," Journal of Regulatory Economics, Springer, vol. 35(3), pages 223-245, June.
    7. Kenneth E. Train, 1991. "Optimal Regulation: The Economic Theory of Natural Monopoly," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200848, January.
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    More about this item

    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • L97 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Utilities: General
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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