like F in Figure 11.3. They calculated the average cost of production for the water or electricity companies,

added in an amount for the normal rate of profit the firm should expect to earn, and set the price for

consumers accordingly. This method was known as cost-plus regulation.

Cost-plus regulation raises difficulties of its own. If producers receive reimbursement for their costs, plus a bit

more, then at a minimum, producers have less reason to be concerned with high costs—because they can just

pass them along in higher prices. Worse, firms under cost-plus regulation even have an incentive to generate

high costs by building huge factories or employing many staff, because what they can charge is linked to the

costs they incur.

Thus, in the 1980s and 1990s, some public utility regulators began to use price cap regulation, where the

regulator sets a price that the firm can charge over the next few years. A common pattern was to require a price
{"source": "downloads\\business\\economics\\Microeconomics3e.pdf", "total_pages": 597, "file_type": ".pdf", "upload_timestamp": "2026-02-07T15:37:44.339247", "producer": "Prince 14.2 (www.princexml.com)", "file_name": "Microeconomics3e.pdf", "creationdate": "2022-12-07T14:15:44-06:00", "batch_upload": true, "source_file": "downloads\\business\\economics\\Microeconomics3e.pdf", "title": "Principles of Microeconomics 3e", "creator": "PDFMiner", "file_hash": "830b81f41611ac67a490444dbb5d6aed292224606965b06965b914443c93331a", "file_size_mb": 26.99, "moddate": "2022-12-07T14:23:05-06:00", "uploaded_via": "batch_uploader"}