Regulation: Price Cap and Revenue Cap

Price cap regulation allows the operator to change its price level according to an index that is typically comprised of an inflation measure, I, and a “productivity offset,” which is more commonly called the X-factor. Typically with price cap regulation, the regulator groups services into price or service baskets and establishes an I–X index, called a price cap index, for each basket. Establishing price baskets allows the operator to change prices within the basket as the operator sees fit as long as the average percentage change in prices for the services in the basket does not exceed the price cap index for the basket. Revenue cap regulation is similar to price cap regulation in that the regulator establishes an I–X index, which in this case is called a revenue cap index, for service baskets and allows the operator to change prices within the basket so long as the percentage change in revenue does not exceed the revenue cap index. Revenue cap regulation is more appropriate than price cap regulation when costs do not vary appreciably with units of sales.