Price-Cap Regulation and the Scale and Timing of Investment
Lewis T. Evans
Victoria University of Wellington - New Zealand Institute for Study of Competition and Regulation Inc. (ISCR)
Victoria University of Wellington - School of Economics & Finance
November 23, 2011
This paper shows how scale economies affect welfare-maximizing regulation and regulated firms’ investment behavior. Price-regulated firms take less advantage of scale economies than social planners, with greater investment distortions for greater economies of scale. Price caps should be below the caps implied by planners’ investment programs for moderate economies of scale, and above them otherwise. Despite quantity regulation raising the average cost of building capacity, price caps should be lower when quantity is regulated. Immediately after firms make their initial investment, regulators want to transfer surplus from customers to shareholders by raising the price cap in order to fund service improvements.
Number of Pages in PDF File: 28
Keywords: regulation, natural monopoly, economies of scale, investment, real options
JEL Classification: D21, D42, D92, G31, L51, L98working papers series
Date posted: May 1, 2011 ; Last revised: November 23, 2011
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