Price-Level Regulation and Its Reform

James Ming Chen, Price-Level Regulation and Its Reform, http://ssrn.com/abstract=771226 or http://bit.ly/PriceLevelRegulation:

Price-level, or “price-cap,” regulation offers an alluring alternative to the traditional technique of monitoring a regulated firm’s profits. Part II of this article contrasts price-level regulation with conventional cost-of-service ratemaking and with Ramsey pricing. Price-level regulation stands as a market-based, incentive-driven “third way” between traditional regulation and complete deregulation. Part III provides formal specifications of price-level regulation. Although some jurisdictions have set price caps according to operating cost and rate-of-return calculations that clearly parallel those steps in conventional ratemaking, this article will focus on price-level methodologies that combine an economy-wide measure of inflation with an x-factor reflecting total factor productivity within a regulated industry.

Part IV addresses the simpler component of price-level regulation, the choice of an inflation index. Part V devotes detailed attention to the treatment of the x-factor by two federal ratemaking agencies, the Federal Energy Regulatory Commission (FERC) and the Federal Communications Commission (FCC). Closer examination of price cap methodologies adopted by FERC and the FCC suggests that price-level regulation based on inflation and an industry-specific X factor may be further streamlined. Part VI describes how price-level regulation might be accomplished through the application of a single, industry-specific index of input costs.