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Cost‐Padding in Profit‐Regulated Firms*
Author(s) -
ALBON ROBERT P.,
KIRBY MICHAEL G.
Publication year - 1983
Publication title -
economic record
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.365
H-Index - 42
eISSN - 1475-4932
pISSN - 0013-0249
DOI - 10.1111/j.1475-4932.1983.tb00577.x
Subject(s) - monopoly , incentive , natural monopoly , profit (economics) , economics , industrial organization , context (archaeology) , microeconomics , business , welfare , outcome (game theory) , market economy , paleontology , biology
When entry into an industry is restricted, economic regulation of that industry is often directed at preventing existing firms from monopoly pricing behaviour. One form of such regulation is to set prices so as to control the level of profits earned by these firms. This paper briefly reviews the relevant economic literature and presents a model of the regulated firm in which such price‐setting procedures provide an incentive to inflate costs above minimum levels. The welfare cost of this form of regulation can then exceed that occurring at the unconstrained monopoly outcome. The setting of air fares under the Two‐Airline Policy and the regulation of natural gas in NSW are discussed in the context of this analysis.