Diversification Incentives under "Price-Based" and "Cost-Based" Regulation

Ronald R. Braeutigam and John C. Panzar

RAND Journal of Economics, 1989, vol. 20, issue 3, 373-391

Abstract: This article considers two schemes of regulation for firms that serve both monopoly markets and markets subjected to substantial competition. The first form ("cost-based" regulation) combines elements of rate-of-return regulation (on monopoly markets) with fully distributed cost pricing, much like the form of regulation currently in place in the domestic telephone industry. The second form ("price-based" regulation) would establish rate caps on noncompetitive services, and allow the firm to enter into competitive markets and charge whatever prices it might like in those markets. Models of both forms of regulation are developed and analyzed with respect to incentives for cost misreporting, choice of technology, cost-reducing innovation, choices of prices and output levels, and diversification into competitive markets.

Date: 1989
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