 Cost Padding in Regulated Markets with Demand UncertaintyNo 72, Working Papers in Public Economics from Department of Economics and Law, Sapienza University of Roma Abstract: This paper presents a simple model of a non-competitive market with demand uncertainty in which firms can choose their technology of production. Technology is characterised by two parameters: capacity and flexibility. The first has a strong commitment value while flexibility is needed to face uncertainty. Lack of competition requires active regulation to ensure that the price is not set at excessive level. When choosing their technology, firms take into account not only the effects of this choice on the opponent(s) but also the effect on the regulated price. In this framework, and because of regulation, firms have an incentive to manipulate their costs (cost padding). This causes monopoly regulation aiming at improving allocative efficiency to be ineffective. Increasing the number of firms in the market may restore regulation effectiveness. The reason is that if demand is sufficiently volatile, then firms strategically choose flexible techniques and this effect dominates over the incentive to manipulate costs in order to escape regulation. In this case regulation is effective precisely because cost padding is hampered by firms’ non-cooperative behaviour. Keywords: Strategic Behaviour; Cost Padding; Regulation; Demand Uncertainty. (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:sap:wpaper:wp72 Access Statistics for this paper More papers in Working Papers in Public Economics from Department of Economics and Law, Sapienza University of Roma |
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