Price caps

Price-cap regulation of AT&T, which became effective on July 1, 1989, is an example of an idea that made its way from economic theory to institutional practice; in this case the process took about seven years. The authors describe both price-cap regulation and its predecessor-rate-of-return regulation-with particular regard to their incentive properties. They then give the assumptions and conclusions of a theoretical study (in fact a principal-agent model) that bears on the likely effectiveness of price-cap regulation. In the concluding section the authors describe some aspects of the progress of this idea from theory to practice, and draw tentative conclusions about the conditions that made it possible for this progress to be successfully completed.