Edited by David Parker and David Saal
Chapter 23: Regulating Prices and Profits
23 Regulating prices and proﬁts Thomas Weyman-Jones Introduction Regulatory theory concerns the behaviour of the proﬁt-maximizing ﬁrm engaged in a game with a regulator who is often not well informed about the ﬁrm’s costs. Regulatory practice is concerned with companies owned by investors and operating in speciﬁc markets under regulated accounting procedures. Dieter Bös (Chapter 22) has admirably surveyed the theory of regulation and this chapter complements that chapter by addressing the issues of regulatory practice in setting prices and their relationship with the company’s proﬁts. The context is largely that of price cap regulation, which is becoming widely adopted throughout Europe, Australia, New Zealand and parts of the USA, and in many other developing and transition economies, especially where international bodies such as the World Bank have a role in infrastructure ﬁnancing. Price cap regulation sets the maximum average revenue that a company is allowed to charge for its outputs for a speciﬁc price control period. This usually takes the form of RPI Ϫ X price capping in which the initial price is allowed to escalate at an annual percentage rate equal to RPI Ϫ X, where RPI is the annual growth rate in the consumer price index and X is a productivity growth rate. Numerous major issues must be determined: the weights used to calculate the company’s average revenue; the initial price or average revenue for the next period, P0; the productivity growth X factor; the benchmark levels of operating expenditure, capital expenditure and...
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