A Sequential Mechanism for Direct Price Regulation

  • Peter B. Linhart
  • Roy Radner
  • Frank W. Sinden
Part of the Topics in Regulatory Economics and Policy Series book series (TREP, volume 6)


In this article, we describe a mathematical model of price-cap regulation, in a simplified institutional setting. We show that, even in the presence of uncertainty as to the success of actions taken to improve productivity, and even in the presence of moral hazard, such a regulatory method can achieve its aim—namely, decreasing output prices and increasing productivity.1 Thus we consider the problem faced by a regulator who wants to provide incentives for a firm to effect cost reductions—and hence price reductions—through technological change or by other means. We model the manager of the firm as facing constraints imposed by the shareholders and other providers of capital, by the customers, and by the regulator. The regulator’s ultimate objective is a secular real decrease in the firm’s prices. However, the manager’s private utility may not be maximized by activities that are maximally cost-reducing. Moreover, the regulator cannot directly observe all of the manager’s actions, the outcomes of which are also influenced by random exogenous events. Hence a problem of moral hazard arises.


Recovery Phase Moral Hazard Incentive Regulation Price Decrease Incentive Phase 
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Copyright information

© Springer Science+Business Media New York 1991

Authors and Affiliations

  • Peter B. Linhart
  • Roy Radner
  • Frank W. Sinden

There are no affiliations available

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