Hybrid revenue caps and incentive regulation

Abstract

This paper analyzes the incentive effects of a hybrid revenue cap on a regulated monopolistic firm using non-discriminatory two-part pricing. It is shown that the fixed and the variable part of the cap have different meanings in terms of regulation — the fixed part of a hybrid revenue cap should be used to control the profit level of the regulated firm while the variable part should be used to control the social efficiency level. Since detailed information about the firm's cost function is required to determine the revenue cap parameters, the overall conclusion is that revenue caps are a rather bad idea in the area of incentive regulation.