Friday, February 12, 2010

The Welfare Effects of Use-or-Lose Provisions

Blog readers interested in the efficacy of so-called "use-or-lose" provisions which can be found in both U.S. and EU airline regulations will be interested to read Ian Gale and Daniel O'Brien's new working paper, The Welfare Effects of Use-or-Lose Provisions in Markets with Dominant Firms (Fed. Trade Com'n Working Paper No. 299, Feb. 1, 2010) (available here).  From the abstract:

A use-or-lose provision requires firms to employ a certain minimum fraction of their productive capacity. Variants have been used by regulators in the airline, natural gas transmission, and electric power industries, among others. The primary objective of these provisions is to limit capacity hoarding. We examine the welfare implications of imposing a use-or-lose provision on firms that are able to buy and sell capacity. We find that imposing such a constraint makes it more likely that a dominant firm will purchase capacity from a competitive fringe. Moreover, imposing the constraint makes aggregate output fall if the dominant firm is more efficient than the fringe. If the dominant firm is less efficient than the fringe, aggregate output rises. In both cases, total surplus can rise or fall.

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