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Unformatted text preview: Problem: Regulator does not know costs and demand curve of firm. Firm has incentive to deceive regulator. 23 Forms of regulation: Rate-of-return regulation Price cap regulation 3 26 Rate-of-Return Regulation Firm is allowed to earn a fair return on investment.- Regulatory decides what return on capital is fair.- Prices are set at average cost using fair return on capital. 30 Regulator does not know true cost of capital. Suppose regulator sets fair return at true cost of capital: P = true AC Monopoly has no incentive minimize costs. above true cost of capital: P > true AC Monopoly has incentive to use too much capital. below true cost of capital: P < true AC Monopoly becomes insolvent. 33 Price Cap Regulation Commission sets a price cap. Firm can charge any price below that cap. Firm keeps whatever profits it earns....
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This note was uploaded on 07/25/2011 for the course ECON 1 taught by Professor Martholney during the Fall '08 term at University of California, Berkeley.
- Fall '08