Abstract
Building on a simple model proposed by Schmalensee (1989), this paper uses simulation techniques to analyze and compare various regulatory schemes including Schmalensee's family of (linear) “good” regulatory regimes, a price-cap regime allowing for downward price flexibility, and a regime that combines price-cap and profit sharing. The quantitative analysis pays particular attention to measuring the trade-off between rent extraction and incentives for efficiency. The main findings of this study can be summarized as follows. First, it appears that pure price-cap regulation leaves substantial rent to the firm relative to the other regimes. Second, introducing room for downward price flexibility improves efficiency of price-cap over Schmalensee's linear regulatory regimes. Finally, by correcting in part for the distributional distortion of price-cap, the profit-sharing mechanism often yields levels of welfare comparable to optimal regulation levels.
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Gasmi, F., Ivaldi, M. & Laffont, J.J. Rent extraction and incentives for efficiency in recent regulatory proposals. J Regul Econ 6, 151–176 (1994). https://doi.org/10.1007/BF01065748
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DOI: https://doi.org/10.1007/BF01065748