regulation price cap and revenue cap.pdf

1 REGULATION: PRICE CAP AND REVENUE CAP Mark A. Jamison Public Utility Research Center University of Florida . Box 117142 Gainesville, FL 32611-7142 mark.******@ Abstract Price cap regulation allows the ope rator to change its price level according to an index that is prised of an inflation measure, I, and a “productivity offset,” which is more commonly called the X-factor. Typically with pri ce cap regulation, the regulator groups services into price or service baskets and establishes an I – X index, called a price cap index, for each basket. Establishing price baskets allows the operator to change prices within the basket as the operator sees fit as long as the average percentage change in prices for the services in the basket does not exceed the price cap index for the basket. Revenue cap regulation is similar to price cap regulation in that the regulator establishes an I – X index, which in this case is called a revenue cap index, for service baskets and allows the operator to change pr ices within the basket so long as the percentage change in revenue does not exceed the revenue cap index. Revenue cap regulation is more appropriate than price cap regula tion when costs do not vary appr eciably with units of sales. Keywords: price caps, incentives, re venue caps, information asymmetry 2 TABLE OF CONTENTS I. INTRODUCTION II. UNDERLYING THEORY III. THE BASIC PRICE RESTRICTION IV. SERVICE BASKETS V. CASE STUDIES IN PRICE CAPS VI. CONCLUSION 3 I. INTRODUCTION Price cap and revenue cap regulation are forms of in centive regulation, which is the use of rewards and penalties to induce the utility company to achieve desired goals and in which the operator is afforded some discretion in achieving goals (1,2 ). With price cap regulation, pany’s average price increase is restricted by a price in dex that generally includ es an inflation measure (such as the . Gross Domestic Product Implicit Price Deflator