Edited by Michael A. Crew and David Parker
Chapter 4: Regulating Prices and Service Quality
Dan Elliott This chapter considers the issues faced by regulators in attempting to establish appropriate standards for the quality of service provided by network companies subject to price regulation. It begins by considering why the separate regulation of service quality arises as an important issue in price-cap regulation. It then considers the options available to regulators in attempting to address this problem. In each case practical applications of how regulators have addressed these problems are described, drawing examples from the water, electricity, rail, telecommunications and postal sectors. The problem of service quality when regulating prices Stephen Littlechild’s original conception of price-cap (RPI – X) regulation for BT was that it provides a simple mechanism that creates incentives for the regulated company to become more efficient, because by reducing costs the firm is able to increase its profits and retain this increase, at least until prices are re-set at a subsequent review (Littlechild, 1983). This may be adequate in simple textbook examples, but when applied in reality regulators must also take into consideration the potential impact of price regulation on the quality of service provided. Competitive markets create incentives to reduce costs, because firms are price takers and cannot pass on excessive costs to their customers. In addition, competition provides incentives for companies to supply the quality of service that customers desire, because customers can choose to switch supplier if they are not satisfied with what they get. Different firms may choose different trade-offs between price and quality, and in this way...
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