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Price-Cap Regulation and the Scale and Timing of InvestmentLewis T. EvansVictoria University of Wellington - New Zealand Institute for Study of Competition and Regulation Inc. (ISCR) Graeme GuthrieVictoria University of Wellington - School of Economics & Finance November 23, 2011 Abstract: 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, L98 working papers seriesDate posted: May 1, 2011 ; Last revised: November 23, 2011Suggested CitationContact Information
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