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The relationship between the costs and prices of a multi-product monopoly: The role of price-cap regulation

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Abstract

This paper examines the role of price-cap regulation in influencing the relationship between the costs and prices of a multi-product monopoly. Based on a simple model of mark-up pricing, a combination of analytical and numerical analysis is used to show how cost increases among the firm's products can cause a divergence of prices from the Ramsey structure if the cost increases are non-uniform or if the demand elasticities for the products are non-uniform. However, in the absence of additional cost changes, profit-maximising prices which are subject to a price-cap constraint converge to the Ramsey structure if the previous period's quantities are used as weights in the firm's price-cap constraint. Consequently, given this formulation of the firm's price-cap constraint, only in situations of recurring cost changes are prices likely to show on-going divergence from the Ramsey structure.

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This paper reports on research funded by the Australian Electricity Supply Industry Research Board. I am grateful to two anonymous referees for their helpful comments on previous versions.

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Fraser, R. The relationship between the costs and prices of a multi-product monopoly: The role of price-cap regulation. J Regul Econ 8, 23–31 (1995). https://doi.org/10.1007/BF01066597

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