Publication: Price caps regulation with capacity precommitment
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2014-08-01
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Abstract
In order to examine the effectiveness of price caps to regulate imperfectly competitive markets in
which the demand is uncertain, we study a monopoly that makes irreversible capacity investments
ex-ante, and then chooses its output upon observing the realization of demand. When capacity
decisions have no precommitment value, price cap regulation remains fully effective. With
capacity precommitment, however, the optimal price cap must trade off the incentives for capacity
investment and capacity withholding, and is above the unit cost of capacity. While a price cap
mitigates market power, it cannot eliminate inefficiencies. Capacity payments provide a useful
complementary instrument.
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Monopoly, Market Power, Price Cap Regulation, Capacity Investment, Capacity Withholding, Demand Uncertainty