Capital bias in the Nordic revenue cap regulation: Averch-Johnson critique revisited

Timo Kuosmanen, Tuan Nguyen

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Nordic energy market reform and the regulation of local monopolies in electricity transmission and distribution sectors have served as role models for many other countries worldwide. The first contribution of this paper is to clarify the conceptual distinction between the Nordic revenue cap approach and the British revenue cap regulation. Our second contribution is to show that the Nordic revenue cap is similar to the U.S.-style rate of return regulation in that both are subject to capital bias, known as the Averch-Johnson effect. The third contribution of this paper is to examine the magnitude of the capital bias and its welfare effects by means of numerical simulations. We show that the Nordic revenue cap generally decreases the monopoly profit, increases the output, decreases the price, and hence increases consumer surplus compared to the unregulated monopoly. The simulation results prove robust to changes in the parameter values and the functional form of the production function. Our numerical simulations reveal that relatively light handed regulation suffices to yield the main benefits.
Original languageEnglish
Article number111355
Pages (from-to)1-10
JournalEnergy Policy
Volume139
DOIs
Publication statusPublished - Apr 2020
MoE publication typeA1 Journal article-refereed

Keywords

  • Electricity transmission and distribution
  • Incentive regulation
  • Monopoly
  • Price-cap
  • Revenue-cap

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