Applying a price cap: rab and regulatory accounting

Abstract

A “price cap” is not but a cap on prices. In the concept of regulation it implies that the regulator does not set the price, the regulator leaves some room for a pricing policy that is designed and implemented by the company, subject to limitations in the interest of the consumer. A price cap may allow for some flexibility but not much; there will always be a maximum price. A regulator can set a cap on the “average” price of a unit of service, so that the company can offer different combinations between a fixed charge and a unit service charge, or apply different prices at different hours of the day or on different days of the year. A cap on the average price has to be accompanied by strong monitoring in order to prevent undue discrimination among customers. The company will be wise to apply higher prices to peak-time demand, and this is also socially rational; but applying higher prices to the more rigid sections of the demand curve (Ramsey pricing) may be efficient from the point of view of allocation but unacceptable from the point of view of distribution. Another possibility is to set a cap on revenues. Setting a cap on total revenues, or on average prices (equal to average revenues), implies a choice of a level of generality; the regulator can impose a cap on the (total or average) revenues from selling the service to a category of customers, or a general cap on all revenues. This implies different degrees of possible cross subsidies among categories of customers. The trade-off is between risking the allowance of cross subsidies and setting too rigid a discipline, which would prevent the company fro meeting different tastes or needs of different types of customers, or from practicing a rational peak-load pricing policy. There is a different notion of the price cap, dealing with adjustment in time. This has to do with the task of designing price controls which include an incentive to efficiency; in other words, the task of artificially reproducing the incentives, which are usually provided by competition, in a context of regulated monopoly. This is where the CPI-X comes in to play. Each year the tariff is increased by a factor proportional to the Consumer Price Index (CPI) and decreased by a factor measuring the increase in efficiency (X) that the regulator expects from the company, on the basis of experience and comparisons) formula. Therefore, we have a static and dynamic notion of price cap. Both can be expressed in terms of capping the price (tariff) or the revenue. Both have an importance in regulation, but have different roles. In any debate it is important that it be made clear which one is being discussed.