Abstract
There are essentially two methods for defining fair prices in regulated industries. The first method, known as rate of return regulation, routinely fixes prices in the amount of the actual costs.1,2 The second method, known as RPI-X regulation, defines prices on the basis of a price or profit formula.3 In this case, the price of the current period consists of the price of the previous period subtracted by the mandatory efficiency boosts that take the form of price surcharges and price increases, in order to compensate for the general price escalation.4 In the following, both of these different systems will be defined more carefully. On the basis of the principle agent theory, a statement is made in Sect. 3.2 about which different incentive effects both of these systems have intrinsically for boosting efficiency in providing a service.
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Notes
- 1.
Synonyms used for this type of price regulation are also “individual cost audit system”, “cost-based price regulation” and “Return regulation”.
- 2.
For a rate of return regulation system, actual costs do not have to be used in practice for fixing prices; budget costs or target costs can also be implemented; cf. Sect. 2.3.3 of this work. For reasons of simplification, implementing actual costs should be assumed, in order to simplify the difference between rate of return regulation systems and RPI-X regulation systems.
- 3.
Synonyms used for this type of price regulation are also “Revenue cap regulation”, “Price cap regulation” and “multiple-period incentive regulation”.
- 4.
The expression “RPI-X regulation” is derived from both of the factors listed. “RPI” stands for the factor related to price increase from inflation (Retail-Price-Index) and “X” for the factor related to efficiency increase.
- 5.
An introduction to the principal agent theory is given by Macho-Stadler and Perez-Castrillo (2001), among others.
- 6.
cf. Laffont and Tirole (1986), p. 614 ff.
- 7.
cf. Currier (2004), p. 51 ff.
- 8.
- 9.
cf. Currier (2004), p. 53 f.
- 10.
cf. Braeutigam and Panzar (1989), p. 373 ff.
- 11.
cf. Braeutigam and Panzar (1989), p. 378.
- 12.
cf. Braeutigam and Panzar, p. 381.
- 13.
cf. Braeutigam and Panzar, p. 382.
- 14.
cf. Braeutigam and Panzar (1989), p. 387 ff.
- 15.
cf. Braeutigam and Panzar (1989), p. 388.
- 16.
cf. Braeutigam and Panzar (1989), p. 389.
- 17.
cf. Taggart (1985), p. 259.
- 18.
cf. Peltzman (1976), p. 230.
- 19.
cf. Fraser and Kannan (1990), p. 68.
- 20.
cf. Swoboda (1996), p. 377.
- 21.
f. Fraser and Kannan (1990), p. 68 f.
- 22.
Joskow and MacAvoy allege, for example, that price audits in the USA last around 12 months and are based on data from the closed fiscal year, from which delays of several years can result in terms of cost allocation to customers, cf. Joskow and MacAvoy (1975), p. 296.
- 23.
cf. Joskow and MacAvoy (1975), p. 297.
- 24.
cf. Navarro (1983).
- 25.
cf. Davidson and Chandy (1983).
- 26.
cf. Davidson and Chandy (1983), p. 51.
- 27.
Davidson and Chandy justify the significance of this criterion as follows: “… The importance of this variable may be attributable to the degree of certainty with which investors can anticipate an appointed commissioner´s attitude toward utility rate increase. Investors may feel better able to anticipate the character of a commissioner who is appointed by the governor of the state than one who is chosen by election. …”, Davidson and Chandy (1983), p. 51 f.
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Hierzenberger, M. (2010). Methods of Price Regulation. In: Price Regulation and Risk. Lecture Notes in Economics and Mathematical Systems, vol 641. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-12047-3_3
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