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OverviewElectricity transmission pricing and transmission grid expansion have received increasing regulatory and analytical attention in recent years. Since electricity transmission is a very special service with unusual characteristics, such as loop flows, the approaches have been largely tailor-made and not simply taken from the general economic literature or from the more specific but still general incentive regulation literature. An exception has been Vogelsang (2001), who postulated transmission cost and demand functions with fairly general properties and then adapted known regulatory adjustment processes to the electricity transmission problem. A concern with this approach has been that the properties of transmission cost and demand functions are little known but are suspected to differ from conventional functional forms. The assumed cost and demand properties in Vogelsang (2001) may actually not hold for transmission companies (Transcos). Loop-flows imply that certain investments in transmission upgrades cause negative network effects on other transmission links, so that capacity is multidimensional. Total network capacity might even decrease due to the addition of new capacity in certain transmission links. The transmission capacity cost function can be discontinuous. There are two disparate approaches to transmission investment: one employs the theory based on long-run financial rights (LTFTR) to transmission (merchant approach), while the other is based on the incentive-regulation hypothesis (regulatory approach). An independent system operator (ISO) handles the actual dispatch and operational pricing. The transmission firm is regulated through benchmark or price regulation to provide long-term investment incentives while avoiding congestion. In this paper we consider the elements that could combine the merchant and regulatory approaches in a setting with price-taking electricity generators and loads. MethodsBased on LTFTRs, merchant mechanisms are easiest to understand for incrementally small expansions in meshed networks under an ISO environment. The price-cap method seeks to regulate a monopoly Transco. The regulatory goal in this paper is an extension of Vogelsang (2001) for meshed projects. Transmission output is redefined in terms of incremental LTFTRs (or total LTFTRs, if a long period is assumed) so as to be able to apply the Vogelsang's incentive mechanism to a meshed network. For lumpy and large transmission projects a fixed part of the tariff plays the role of a complementary charge. The variable part of the tariff is based on nodal prices; pricing for the different cost components of transmission is such that they do not conflict with each other (fixed costs are allocated so that the variable charges are able to reflect nodal prices); variations in fixed charges over time partially counteract the variability of nodal prices giving some price insurance to the market participants. * Contact author: División de Economía, CIDE, Carret. México-Toluca 3655, Lomas de Santa Fé, C.P. 01210,...