“Pricing Discretion and Price-cap Regulation”

This paper analyses how limiting the pricing discretion by a price capped firm can affect its pricing decision and the entry decision by potential competitors. We focus on two regulatory regimes. A first regime (Absolute) is given by the combination of an average price cap and an additional constraint on the absolute level of prices in the monopolistic markets. An alternative regime (Relative) entails, along with the price cap constraint, a constraint on the ratio between prices in monopolistic and captive markets. The main findings of the paper are as follows. Prices in the competitive (captive) market are generally higher (lower) under the Relative regime. The Relative regime generally grants higher likelihood of entry at a given scale and gives rise to higher aggregate consumers’ surplus when, differently than the Absolute regime, it is able to foster entry. However, when entry occurs under both regimes, the Absolute regime brings about (weakly) higher aggregate consumers’ surplus. The ranking between the two regimes is reversed when they are evaluated in terms of industry profits. The effect on social welfare as given by a weighted sum of aggregate consumers’ surplus and industry profits is indeterminate.