Dynamics of Price Regulation
Volume: Volume 31, No. 4
Issue: Winter 2000
Pages: pp. 744-767
Authors: Gary Biglaiser and Michael Riordan
Title: Dynamics of Price Regulation
Abstract: We study the dynamics of price regulation for an industry adjusting to exogenous technological progress. First, we characterize the optimal capacity path and replacement cycles in a neoclassical investment model. Second, we show that naive rate-of-return regulation, which ignores components of economic depreciation, eventually results in a deficient level of capacity due to excessively high retail prices burdened by the need to recover the underdepreciated costs of historical investments. Third, we explain how price-cap regulation leads to more efficient capital replacement decisions compared to naive rate-of-return regulation, and we show how finite price-cap horizons distort capital replacement decisions compared to optimal regulation. Finally, we interpret recent regulatory reforms in telecommunications markets.
JEL Classification
Economics of Regulation (L510 )
Telecommunications (L960 )
Regulation