A Pedagogical Note on the Superiority of Price-Cap Regulation to Rate-of-Return Regulation
Kevin Currier and
Brian K. Jackson
The Journal of Economic Education, 2008, vol. 39, issue 3, 261-268
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 because of the former's potential to generate more efficient pricing structures and strong incentives for cost reduction. However, price-cap regulation has received little attention in microeconomics textbooks. The authors provide a simple discussion of price-cap regulation that demonstrates its superiority over conventional rate-of-return regulation, which forms the basis for a lecture on contemporary natural monopoly regulation.
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