Journal Article

On Price Caps Under Uncertainty

Robert Earle, Karl Schmedders and Tymon Tatur

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 74, issue 1, pages 93-111
Published in print January 2007 | ISSN: 0034-6527
Published online January 2007 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2007.00415.x
On Price Caps Under Uncertainty

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This paper shows how standard arguments supporting the imposition of price caps break down in the presence of demand uncertainty. In particular, though in the deterministic case the introduction or lowering of a price cap (above marginal cost) results in increased production, increased total welfare, decreased prices, and increased consumer welfare, we show that all of the above comparative statics predictions fail for generic uncertain demand functions. For example, for price caps sufficiently close to marginal cost, a decrease in the price cap always leads to a decrease in production and total welfare under certain mild conditions. Under stronger regularity assumptions, all of the monotone comparative statics predictions from the deterministic case also do not hold for a generic uncertain demand if we restrict attention to price caps in an arbitrary fixed interval (as long as the price caps are binding for some values in that interval).

Keywords: L12; L13; L71; Q48

Journal Article.  10647 words.  Illustrated.

Subjects: Primary Products ; Energy Economics ; Market Structure, Firm Strategy, and Market Performance

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