The Australian Energy Market Commission has asked us to compare the strength of incentives facing regulated firms under two different approaches to setting price controls: the current “building-blocks” approach, and the alternative Total Factor Productivity approach put forward by the Victorian Government in its recent electricity rule change proposal (“VTFP”). We have concentrated on comparing the specific TFP proposal put forward by the Victorian Government with the building-blocks approach as currently set out in the National Electricity Rules and applied by the Australian Energy Regulator, but we also discuss related ideas that have been raised during recent debate over the merits of TFP in the context of Australian energy regulation. Where relevant, we also make observations about TFP-based and building-blocks type price controls more generally, including designs which focus on strengthening incentives.

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