Regulatory tune-ups

Regulators cannot continuously and perfectly monitor firms. The alternative considered here supposes the regulator sets prices at discrete, unforeseen , times. I show that when marginal cost follows a stochastic diffusion proc ess, but the regulator only irregularly adjusts the regulated price, the op timal price may be less than or greater than the expected level of marginal costs. The regulated price should be higher the steeper the demand curve, the lower the discount rate, and the greater the variance of costs. The soc ial benefit of changing the price following a change in marginal cost is us ually greater if at the time price was set marginal cost was low. (C) 2001 Elsevier Science BM All rights reserved.