Revenue-cap regulation
Encyclopedia
Revenue-cap regulation is a system for setting the prices charged by regulated monopolies
by limiting the total revenue in a given period. It is contrasted with rate-of-return regulation
, in which utilities are permitted a set rate of return
on capital, and with price-cap regulation
where price is the regulated variable.
As with price-cap regulation, the system uses "CPI - X", or, in the United Kingdom "RPI-X" to set revenue caps. This takes the rate of inflation
, measured by the Consumer Price Index
(UK Retail Prices Index
, RPI) and subtracts expected efficiency savings X. 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
.
The choice of a revenue-cap rather than a price cap means that the regulated enterprise does not face any quantity risk. This may be appropriate in cases, such as electricity distribution, where the quantity demanded is largely outside the control of the regulated firm, and where costs may be insensitive to short-term variations in quantity demanded.
In practice, the distinction between revenue-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.
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
by limiting the total revenue in a given period. It is contrasted with rate-of-return regulation
Rate-of-return regulation
Rate-of-return regulation is a system for setting the prices charged by regulated monopolies. The central idea is that monopoly firms should be required to charge the price that would prevail in a competitive market, which is equal to efficient costs of production plus a market-determined rate of...
, in which utilities are permitted a set rate of return
Rate of return
In finance, rate of return , also known as return on investment , rate of profit or sometimes just return, is the ratio of money gained or lost on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or...
on capital, and with price-cap regulation
Price-cap regulation
Price-cap regulation is a form of regulation designed in the 1980s by UK Treasury economist Stephen Littlechild, which has been applied to all of the privatized British network utilities...
where price is the regulated variable.
As with price-cap regulation, the system uses "CPI - X", or, in the United Kingdom "RPI-X" to set revenue caps. This takes the rate of inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
, measured by the Consumer Price Index
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
(UK Retail Prices Index
Retail Prices Index (United Kingdom)
In the United Kingdom, the Retail Prices Index or Retail Price Index is a measure of inflation published monthly by the Office for National Statistics. It measures the change in the cost of a basket of retail goods and services.-History:...
, RPI) and subtracts expected efficiency savings X. 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
Natural monopoly
A monopoly describes a situation where all sales in a market are undertaken by a single firm. A natural monopoly by contrast is a condition on the cost-technology of an industry whereby it is most efficient for production to be concentrated in a single form...
.
The choice of a revenue-cap rather than a price cap means that the regulated enterprise does not face any quantity risk. This may be appropriate in cases, such as electricity distribution, where the quantity demanded is largely outside the control of the regulated firm, and where costs may be insensitive to short-term variations in quantity demanded.
In practice, the distinction between revenue-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.