Price-Cap Regulation and the Scale and Timing of Investment

28 Pages Posted: 1 May 2011 Last revised: 23 Nov 2011

See all articles by Lewis T. Evans

Lewis T. Evans

Victoria University of Wellington - New Zealand Institute for Study of Competition and Regulation Inc. (ISCR)

Graeme Guthrie

Victoria University of Wellington - School of Economics & Finance

Date Written: 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.

Keywords: regulation, natural monopoly, economies of scale, investment, real options

JEL Classification: D21, D42, D92, G31, L51, L98

Suggested Citation

Evans, Lewis T. and Guthrie, Graeme, Price-Cap Regulation and the Scale and Timing of Investment (November 23, 2011). Available at SSRN: https://ssrn.com/abstract=1826662 or http://dx.doi.org/10.2139/ssrn.1826662

Lewis T. Evans

Victoria University of Wellington - New Zealand Institute for Study of Competition and Regulation Inc. (ISCR) ( email )

Wellington 6001
New Zealand
64 4 4635562 (Phone)
64 4 4635566 (Fax)

Graeme Guthrie (Contact Author)

Victoria University of Wellington - School of Economics & Finance ( email )

P.O. Box 600
Wellington 6140
New Zealand
64 4 463 5763 (Phone)

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