A practical approach to quality-adjusted price cap regulation

Price cap regulation is often combined with service quality regulation since price caps may create incentives for quality degradation. A service quality adjustment factor (the Q-Factor) in the price cap formula ensures that allowed prices fall as quality declines. This paper discusses some considerations in determining the appropriate form of the Q-Factor. The paper examines the difficulties involved in exploiting the price/quality tradeoff. In addition, the paper presents a quality-corrected price cap procedure—possessing desirable properties—that can be implemented with reasonable informational requirements.