Ingo Vogelsang

A Regulatory Adjustment Process for Optimal Pricing by Multiproduct Monopoly Firms

This paper describes an incentive mechanism that is shown to enforce the use of Ramsey prices by multiproduct monopolies. The constraint given is simple. It limits information requirements on the regulatory agency to bookkeeping data of the firm. Its implementation could be easily controlled by outside courts or auditors. The process, therefore, makes use of invisible hand properties shifting the workload of welfare optimization from the regulatory agency to the regulated firm.

Price Regulation of Access to Telecommunications Networks

Without access of networks to each other, competition in the telecommunications sector would hardly have spread so quickly. Such mutual access is necessary for carriers to provide ubiquitous service and enable end-users to call and be called by anybody without subscribing to a system-wide monopolist. One-way access concerns bottleneck inputs provided by an incumbent network to entrants, while two-way access concerns the interconnection between networks. Whereas one-way access regulation is exclusively driven by containment of market power, two-way access is additionally affected by collusion possibilities. Among the numerous pricing rules discussed, none clearly dominates. This article provides a roadmap vis-a-vis the competing policy objectives for access price regulation.

Incentive Regulation and Competition in Public Utility Markets: A 20-Year Perspective

Over the last 20 years, incentives in general and price caps in particular have breathed new life into public utility regulation. Price caps successfully combine incentives for cost reduction with incentives for more efficient pricing. These properties also facilitate opening public utility sectors to competition. Relatively tight price caps likely imply the right amount of competition, when the underlying natural market structure is unknown. While price caps make a regulated incumbent competitively more aggressive, this aggression is likely to improve on the unregulated outcome. Potentially anticompetitive behavior by the incumbent has led to regulation of essential inputs on the basis of benchmarked costs. Benchmarked costs should evolve into price caps for essential inputs and eventually lead to partial deregulation of end-user prices.

Price Regulation for Independent Transmission Companies

This paper considers methods of price structure regulation of electricity transmission in the context of an independent transmission company (TRANSCO). The focus is on two-part tariffs where the variable part would reflect congestion charges (and ancillary services) while the fixed part would reflect capacity costs. The two-part tariffs form a price-cap index, and the firm could rebalance prices, as long as the index satisfies the price-cap constraint. The firm would then have incentives to trade off congestion against capacity expansion in such a way that it becomes profitable to expand, whenever the costs of congestion on average exceed the costs of expansion. However, with chained Laspeyres weights in the price-cap index expansion may be suboptimal. We therefore discuss ways to improve the expansion factor. Implementing the regulatory schemes considered suggests a hybrid approach combining a TRANSCO with an independent system operator (ISO).

The relationship between mobile and fixed-line communications: A survey

The dramatic worldwide increase in mobile communication that has led to more than 4 billion users has over the last few years been accompanied in wealthy countries by a significant decline in fixed network subscriptions. Such fixed-to-mobile substitution (FMS) is at the center of this literature survey. Theoretical models explaining FMS are scarce and are inconclusive regarding the balance between substitution and complementarity of the fixed and mobile sectors. Empirical explanations hinge on the interaction of positive cross-elasticities of demand and reductions in mobile relative to fixed communications prices. FMS is also supported by relative declines in mobile network costs, network effects in demand and quality improvements of mobile services. The policy consequences of FMS stem from the potential reductions in market power of operators in fixed-line markets and from the ability of mobile operators to enable universal service. The survey reveals ample opportunity for further empirical and theoretical research in the area of FMS.

Price Cap Regulation of Telecommunications Services: A Long-Run Approach

With its recent Notice of Proposed Rulemaking the United States Federal Communications Commission (FCC 1987) has opened a discussion about the possible use of price caps to replace rate-of-return regulation for telecommunications services. The basic idea of these price caps is closely related to the RPI-X formula suggested by Littlechild (1983) for British Telecom and implemented there, along with British Telecom’s privatization, in 1984. This formula says that over a period of at least five years British Telecom is constrained in adjusting the prices for a basket of its basic services by the condition that the weighted average of these prices increase by no more than the Retail Price Index less “X” percent. In the prices of its other (nonbasic) services, British Telecom is only constrained by the market and by general laws on competition.

Incentive Regulation, Investments and Technological Change

Based on an idiosyncratic reading of the literature I propose intermediate (rather than tight or soft) regulation for balancing investment incentives with allocative efficiency and competition objectives. Intermediate regulation is compatible with incentive regulation and helps lengthening the regulatory commitment period necessary for incentives. However, such commitment for the whole time horizon of infrastructure or innovation investments is impossible. The compatibility of incentive regulation and efficient investment is thus in doubt. Incentive regulation for regular infrastructure investments therefore needs periodic updating based on rate-of-return regulation criteria. Innovative infrastructure investments may warrant regulatory holidays, which should be conditioned on strict criteria.

Toward improved and practical incentive regulation

The first half of this paper overviews traditional methods of ratemaking—embedded and marginal cost pricing—and four recent alternatives—automatic rate adjustments, profit-sharing, tariff menus, and the Vogelsang-Finsinger convergence mechanism—that have come to challenge them. We develop a list of nine desirable properties that are suitable to gauge any regulatory mechanism. In the second half of the paper, we explore in greater detail two recent incentive plans—the FCCs price caps approach and a mechanism that the three authors proposed in a FERC document. Based on the nine properties, these two mechanisms are compared.

Two-part tariffs as regulatory constraints

Abstract This paper introduces a regulatory two-part monopoly pricing mechanism with desirable properties. Assuming that firm managers are informed about cost and demand functions, no detailed prior information of the regulator about the regulated firm and its environment is required. Also, subsequent observations of the regulator are restricted to verifiable bookkeeping data. Nevertheless, the pricing formula is simple and easily interpreted. The firm may freely choose the variable price of the two-part tariff as long as the fixed part obeys a constraint. The firm will then in every period receive an approximation to the welfare change caused by its price changes over the last period. Contrary to most other suggestions for incentive pricing the current approach requires no government subsidies.

A Non-Bayesian Incentive Mechanism Using Two-Part Tariffs

The regulatory incentive mechanism to be discussed in this article may be seen as a contribution to the issue of the optimality of marginal cost pricing. The case for and against marginal cost pricing by public utilities has a somewhat dialectic history. Hotelling (1938) set the stage for the thesis by arguing that in decreasing cost industries, buyers should only pay the marginal costs of serving them. The resulting deficit should simply burden the taxpayers. Coase (1945, 1946) soon vehemently opposed this suggestion. He argued first that marginal cost pricing does not pass the test that consumers’ total willingness to pay exceeds production costs of the good in question; second, that subsidies jeopardize efficient operation of the monopoly supplier; and third, that tax financing of subsidies results in an unjustified redistribution from general taxpayers to the consumers of goods produced under increasing returns. However, Coase’s antithesis did not initially win the profession. This took much longer and resulted in Ramsey prices as the synthesis. Ramsey prices maximize total surplus under a balanced budget constraint for the public utility. Such a balanced budget constraint fulfills several functions. It neutralizes income distributional issues between shareholders of the firm and its customers. The shareholders exactly receive a competitive return, neither more nor less. Without any more specific information, it further allows us to state that consumers in total value the output of the public utility at least at production cost. Third, it puts a (sometimes generous) cap on any inefficiencies in the production of the output. Last, it avoids subsidies and the accompanying distortions.