Pakistan Institute of Development Economics



Hold-up Problem in Price Cap Regulation with Limited Ability ofCommitment in High Inflation

In this study, we examine the hold-up problem under price capregulation in developing economies characterised by high inflation thathave a limited ability to commit. The governments of developingcountries are unable to modify the exact inflation rate. If highinflation is brought about by unexpected monetary expansion after theinitial average price is fixed, the insufficient ability to show exactinflation causes a lack of commitment to adjust the initial fixed priceto the modified price. The study’s findings show that those that have alimited ability to commit cause a hold-up problem if inflation issufficiently high for a firm to stop production at the initial price,while the hold-up problem does not occur if inflation is lower and theinitial fixed price generates a sufficient profit for the first-bestinvestment for the firm. JEL Classification: D86, L14, L43,L51 Keywords:Price Cap Regulation, Hold-up Problem, Limited Ability of Commitment,Inflation Adjustment

Takuya Nakaizumi