Price-Cap Regulation and the Scale and Timing of Investment

Price limits and corporate investment: The consumers' perspective

“…All cash flows are discounted at the constant risk-free rate of r, consistent with the realoption literature (Aguerrevere, 2003;Dixit, 1991;Dobbs, 2004;Evans and Guthrie, 2012;Roques and Savva, 2009, etc).…”

“…As in Roques andSavva (2009), Dobbs (2004), and Evans and Guthrie (2012), we assume there are no operating costs. The output quantity cannot exceed the plant capacity Q, while the output price cannot exceed the price cap p; hence both price and quantity are constrained, p ≤ p and q ≤ Q.…”

“…Since distant (rather than immediate) consumers' surplus is less desirable, the surplus stream must be discounted in the same way as a cash flow stream. Thus, the appropriate measure would be the discounted sum of the consumers' surplus stream, discounted at the same rate as the cash flow stream, as in Salant and Woroch (1992) and Evans and Guthrie (2012). Further, since instantaneous consumers' surplus in our model depends on (the stochastic) y, we need to consider the expected present value of the consumers' surplus stream.…”

“…This indirect effect is explicitly incorporated in our model. Evans and Guthrie (2012) examine the effect of price cap on total welfare (consumer welfare plus producer welfare) when the firm makes incremental investments and the regulator adjusts the price cap continuously.…”

Subsidized Capacity Investment Under Uncertainty

“…For instance, Dobbs (2004) argues that the first-best outcome cannot be reached as price cap is used for two goals: optimal investment ex-ante and optimal post-investment pricing. Building on Dobbs (2004), Evans and Guthrie (2012) show that the price cap should be lowered under scale economics where grouping investments across time is cost efficient. By contrast, Willems and Zwart (2017) consider constant returns to scale where it is not optimal to group investments.…”