Price Cap Regulation

Written By
Paul Tracy
Updated November 3, 2020

What is Price Cap Regulation?

A price cap regulation places a ceiling on the amount companies in a given industry (typically utilities and telecommunications providers) can charge for services.

How Does Price Cap Regulation Work?

Price cap regulation typically has four tenets:

1. The regulator establishes a set of acceptable prices for the service. The regulated company can sell its services at any price that is equal to or below the price ceiling. The regulator may also set a price floor to discourage anticompetitive pricing, and it might require companies to refund excess profits.

2. The regulator may group services into baskets and set an overall price cap for them, or it might set a price cap for each individual service. When the regulator caps prices for a basket, the producer can raise the price of one item in the basket as long as it adjusts the prices of the other items in the basket to make the weighted average price equal or fall below the cap.

3. The regulator may adjust a price cap based on changes in industry prices or productivity. The strategy is to reflect the market-clearing price in competitive markets.

4. The regulator periodically reviews the price cap system. It may change the price cap formula or review the profit conditions of a firm.

Why Does Price Cap Regulation Matter?

Price caps depend on several variables, including (but not limited to) efficiency, inflation, and underlying costs, but the idea behind price cap regulation is to protect consumers from price increases and protect utility providers from losses.

The idea is to weaken the relationship between the costs of production and the prices of products and services, but from a financial perspective this can often send mixed messages to managers. For example, because a firm is typically allowed to keep any profits obtained via cost reductions relative to the price cap, in theory price cap regulation increases efficiency. (This differs from traditional regulation, in which the regulator typically allows price increases based on cost increases.) However, a classic criticism of price caps is that this very incentive actually encourages companies to degrade the quality of service in an effort to cut costs.

Activate your free account to unlock our most valuable savings and money-making tips
  • 100% FREE
  • Exclusive money-making tips before we post them to the live site
  • Weekly insights and analysis from our financial experts
  • Free Report - 25 Ways to Save Hundreds on Your Monthly Expenses
  • Free Report - Eliminate Credit Card Debt with these 10 Simple Tricks
Ask an Expert
All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Price Cap Regulation.
Be the first to ask a question

If you have a question about Price Cap Regulation, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

If you have a question about Price Cap Regulation, then please ask Paul.

Ask a question Read more from Paul
Paul Tracy - profile
Ask an Expert about Price Cap Regulation

By submitting this form you agree with our Privacy Policy

Don't Know a Financial Term?
Search our library of 4,000+ terms