Regulating Telecommunications : Lessons from U.S. Price Cap Experience

Price cap regulation uses a formula, set in advance, to determine the price increases for a firm's services for a period of several years. During this period, the firm may keep all the benefits of its incremental productivity gains. Customers can also benefit because the price cap formula may cause prices to rise less rapidly during the period. The sharpened incentives created may encourage the firm to offer innovative new services. After the period ends, regulators may order price reductions that reflect productivity gains during the period. This Note presents the advantages of using price cap over rate-of-return (ROR) in regulating telecommunications carriers. It reviews the U.S. experience with price caps, focusing primarily on federal regulation. It then briefly discusses the lessons of this experience for developing countries.