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“Incentive Regulation: Earnings Sharings, Price Caps, Yardstick Regulation”

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Angewandte Mikro II: Regulations 5th semester

Topic Nr.9: “Incentive Regulation: Earnings Sharings, Price Caps, Yardstick Regulation”
Introduction:
The following work will shortly outline and explain the principle problem of natural monopolies and will then examine different practical solution(s approaches). I will introduce the three closely connected approaches: Earnings sharings regulation, price cap regulation and yardstick regulation, as well as the rate-of-return regulation as the foundation of the former two. In addition to that I will shortly discuss strengths and weaknesses of these approaches and their practical relevance. In that regard I will try to explain why the rather minimalistic price cap approach prevailed against the former, more comprehensive approaches. When a monopoly is able to control its respective market or branch and when it is not forced by the government or other institutions, to include the overall welfare in its productiondecisions, it normally sets price above the economic efficient or pareto efficient price. Thereby it maximizes its own profit at the expense of the overall welfare and the consumers:

Thus (unregulated) monopolies usually result in suboptimal distribution of earnings, and welfare losses. Pareto optimal market clearing generally only occurs on a competitive market. Therefore government usually fights monopolies and oligopolies with regulatory organizations like for example antitrust offices, to grant competition on all markets. However in reality there are a few markets where it is hard to prohibit monopoly or, to be more precise, where a monopoly would be preferable inasmuch as it would be more efficient than a market with economic competition. Monopolies on these markets are so called natural monopolies. In a natural monopoly the production of a certain good or service by only one company (instead of plenty)

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