Regulating Natural Monopoly: Are Price Caps an Alternative to Rate of Return Targets?

Abstract

AbstractAs the process of corporatisation and privatisation of both State and Federal Government Business Enterprises gathers pace, increasing attention is being placed on the way in which these organisations are regulated. The Prices Surveillance Authority has recently proposed a change in the way it conducts surveillance of prices from a cost based system to a price cap system. Price capping, as a form of regulation, has been used extensively in the UK and the US for some time. The article argues that the lesson of this international experience is that price caps may not be the answer to the traditional problems associated with cost based regulation and that price caps may have additional disadvantages, particularly incentives for under investment, although it may have some other advantages. Some alternative regulatory options are then examined, mainly involving modifications to both cost based and price cap regulation.