Setting the X Factor in Price Cap Regulation Plans
Jeffrey I. Bernstein, David E. M. Sappington
NBER Working Paper No. 6622
Despite the popularity of price cap regulation in practice, the economic literature provides relatively little guidance on how to determine the X factor, which is the rate at which inflation -adjusted output prices must fall under price cap plans. We review the standard principles that inform the choice of the X factor, and then consider important extensions. We analyze appropriate modifications of the X factor: (1) when only a subset of the firm's products are subject to price cap regulation, and when product-specific costs and productivity cannot be measured; (2) when the pricing decisions of the regulated firm affect the economy-wide inflation rate; and (3) in the presence of structural changes in the industry, such as a strengthening of competitive forces.
Published: Journal of Regulatory Economics, Vol. 16 (1999): 5-25.