Price Regulation, Investment and the Commitment Problem

42 Pages Posted: 28 Feb 2002

See all articles by Paul Levine

Paul Levine

School of Economics, University of Surrey

Neil Rickman

University of Surrey - Department of Economics

Date Written: February 2002

Abstract

We consider a dynamic model of price regulation with asymmetric information where strategic delegation is available to the regulator. Firms can sink non-contractible, cost-reducing investment but regulators cannot commit to future price levels. We fully characterize the Perfect Bayesian equilibria and show that, with incentive contracts but without delegation, under- and over-investment can occur. We then show that delegation to a suitable regulator can both improve investment incentives and ameliorate the ratchet effect by credibly offering the firm future rent. Simulations indicate significant welfare gains from these two effects and that a wide range of regulatory preferences can achieve this result.

Keywords: Under investment, commitment, price regulation

JEL Classification: L51

Suggested Citation

Levine, Paul L. and Rickman, Neil, Price Regulation, Investment and the Commitment Problem (February 2002). CEPR Discussion Paper No. 3200. Available at SSRN: https://ssrn.com/abstract=302194

Paul L. Levine (Contact Author)

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

Neil Rickman

University of Surrey - Department of Economics ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 689 923 (Phone)
+44 1483 689 548 (Fax)

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