Two-part pricing under revenue cap regulation

Abstract

This paper aims at developing the theoretical understanding of revenue capping as a way of regulating monopolistic firms. It is shown that the fact that a standard monopolist regulated by a fixed revenue cap will raise its price above the unregulated monopoly level is robust to two-part pricing. It is also shown that when regulation of a two-part pricing monopolist is based on a hybrid revenue cap defined as a linear function of quantity, it is the slope of the cap that determines its incentives for efficiencient behaviour while the intercept of the cap only affects the profit level of the firm. This also holds if the cap is defined as a hybrid price-revenue cap. The general conclusion of this is that the slope of the hybrid cap needs to be steeper that the slope of the firm’s cost function in order to prevent the incentive to raise price above the unregulated monopoly level.