495. Energy Efficiency and Price Regulation

Joisa Dutra , Flavio M. Menezes and Xuemei Zheng, School of Economics Discussion Paper No. 495 November 2013, School of Economics, The University of Queensland. Australia.

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Abstract

This paper examines the incentives embedded across di¤erent regulatory regimes – price cap, rate of return and mandated target regulation – for investment in energy efficiency programs at the supplier’ end of the network. In our model, s a monopolist chooses whether or not to undertake an investment in energy efficiency, which is not observable by the regulator. We explore how the monopolist’ s choice of e¤ort changes under di¤erent regulatory regimes. We show that, in equi- librium, the monopolist chooses to exert positive e¤ort more often under price cap regulation than under no regulation or mandated target regulation and that she exerts no effort under rate of return regulation. In terms of expected welfare, however, the results are ambiguous and complex. In particular, we provide a full characterisation of the optimal e¤ort, optimal prices (regulated or unregulated) and expected welfare for the di¤erent regimes and show the trade-o¤s between rent extraction and incentives.