SFB 303 Discussion Paper No. A - 278

Author: Bös, Dieter
Title: Notes on Price-Cap Regulation
Abstract: This paper presents an analysis of a recently invented new form of price regulation. An index of prices of monopolistically supplied goods must never exceed the retail price index minus X. The main results of the chapter are as follows: (i) If the constant X is politically chosen, price-cap regulation does not distort factor inputs. Hence, the government should refrain from sophisticated economic reasoning when choosing X. If X is measured by productivity increases, the firm is punished for high productivity increases, which implies undesired efficieny losses. (ii) The ideal price-cap regulation has exogenous (= political) X and a price index of monopolistically supplied goods which is a subindex of the retail price index. It is shown that this regulation leads to pricing similar to Feldstein (1972a): the consumption of necessities is favored by relatively lower prices. (iii) In practice, sometimes the price index of monopolistically supplied goods is calculated on the basis of revenue weights. This leads to serious distortions of the pricing structure. However, as we show, a simple remedy for these dist ortions is the use of revenue weights which relate to the base period of the retail price index. Then, once again, Feldstein prices are obtained.
Creation-Date: January 1990
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