Competition and Regulation in the Telecommunications Industry in ...

Competition and Regulation in Telecommunicationssystem is that the firm has no incentive to continually reduce cost. Inflated costis created through the attraction of capital rather than efficiency, an incentiveto inflate costs before a rate hearing and the need for very detailed regulation.• Incentive regulation: has been created to deal with the inefficiencies inherentin rate of return regulation. There are two basic types of incentive regulation:o Price-cap regulation: imposition of a price ceiling on a basket of goods,adjustment of the ceiling with the formula CPI-X, where CPI is theconsumer price index and X is the average increase in efficiencyexpected. The potential problem with this mechanism is the uncertaintyabout the true level of cost and hence the crudeness of the mechanism.Errors in the index may lead to windfall gains for the firms or heavylosses. Furthermore the incentive to minimise cost can lead todecreased product quality and to the elimination of goods which do notshow potential for efficiency increases.o Earnings Sharing: whilst price cap regulation achieves cost efficiency,earnings sharing attempts to strike a balance between cost andallocative efficiency. There is a sharing in the risk and rewards from anydeviation in the rate of return between consumers and producers. Theadjusted rate of return is determined by a sharing of the deviation fromthe target rate of return ( ra = rt + h( r* − rt), where 0