Download This PaperA Pedagogical Note on the Superiority of Price Cap Regulation to Rate of Return Regulation
21 Pages Posted: 20 Jun 2006
Date Written: May 26, 2006
Abstract
The two forms of natural monopoly regulation that are typically discussed in Intermediate Microeconomics textbooks are marginal cost pricing and average cost pricing (rate of return regulation). However, within the last 20 years, price cap regulation has largely replaced rate of return regulation due to the formers' potential to generate more efficient pricing structures and strong incentives for cost reduction. Price cap regulation, however, has received little attention in Microeconomics textbooks. This paper provides a simple model of price cap regulation that demonstrates its superiority over conventional rate of return regulation. The present paper thus forms the basis for a lecture on contemporary natural monopoly regulation.
JEL Classification: L43, L51
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