- Price-cap regulation
Price-cap regulation is a form of
regulation designed in the 1980s by UK Treasuryeconomist Stephen Littlechild , which has been applied to all of the privatized British network utilities. It is contrasted withrate-of-return regulation , in which utilities are permitted a setrate of return on capital, and withrevenue-cap regulation where total revenue is the regulated v ""CPI - X", (in the United Kingdom "RPI-X") after the basic formula employed to set price caps. This takes the rate ofinflation , measured by theConsumer Price Index (UKRetail Price Index , RPI) and subtracts expected efficiency savings X. In thewater industry , the formula is "RPI - X + K", where K is based on capital investment requirements. The system is intended to provide incentives for efficiency savings, as any savings above the predicted rate X can be passed on to shareholders, at least until the price caps are next reviewed (usually every five years). A key part of the system is that the rate X is based not only a firm's past performance, but on the performance of other firms in the industry: X is intended to be a proxy for a competitive market, in industries which are natural monopolies.In most industries in the UK, estimation of a firm's efficiency is carried out by comparing regional monopolies and using a
total factor productivity method. However, for telecommunications,Ofcom instead relies on international comparisons.In practice, the distinction between price-cap and rate-of-return regulation may be lost, as regulators may end up making implicit decisions on the acceptable real rates of return on capital employed in order to arrive at price limit determinations. This has been the experience in the UK water sector, where the 1999 periodic review led
Ofwat to determine a standard (real post-tax) cost of capital of 4.75%, with minor adjustments for smaller companies. This standard rate was then used to help calculate X.Price-cap regulation is no longer a uniquely British form of regulation. Particularly in the
telecommunications industry , many Asian countries are implementing some form of price cap on their newly-privatised operators. In addition, many USLocal Exchange Carrier s are now regulated by price-cap rather than rate-of-return regulation: in 2003, of the 73 companies reporting to theARMIS database, 22 were regulated according to an RPI-X price cap (and a further 35 were subject to other retail price controls).ee also
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Ofwat ,Ofgem ,Ofcom
*market failure External links
* [http://www.regulationbodyofknowledge.org/04/narrative/4/ Features of Price Cap and Revenue Cap Regulation] from the [http://www.regulationbodyofknowledge.org Body of Knowledge on Utility Regulation]
* Ian Alexander and Timothy Irwin (1996), "Price Caps, Rate-of-Return Regulation, and the Cost of Capital" [http://rru.worldbank.org/Documents/PublicPolicyJournal/087irwin.pdf]
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