Quality-Adjusted Laspeyres Price Caps: A Graphical Analysis

The strong incentive to reduce costs under price cap regulation may create incentives for a regulated firm to reduce delivered service quality levels. Corrective measures, such as service quality standards or a service quality adjustment factor in the price cap formula may mitigate against this tendency. In this paper, we explore the properties of a regulatory scheme in which a Laspeyres index of prices and qualities is employed by the regulator. Copyright International Atlantic Economic Society 2006