The "Waterbed" Effect and Price Regulation

Schiff Aaron ()
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Schiff Aaron: Department of Economics, University of Auckland

Review of Network Economics, 2008, vol. 7, issue 3, 23

Abstract: This paper investigates conditions that generate the so-called "waterbed" effect under price regulation. This is the effect whereby regulation of one price of a multiproduct firm causes one or more of its unregulated prices to change as a result of the firm's profit-maximizing behavior. A waterbed effect is shown to arise when demands and/or marginal costs are interdependent, firms use nonlinear pricing, or there is a zero-profit constraint or global price cap. Some implications for market definition, welfare analysis of regulation, non-price competition, collusion and two-sided markets are also discussed, as well as specific applications to fixed-to-mobile termination and bank overcharges.

Date: 2008
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DOI: 10.2202/1446-9022.1155

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